Correlation
A measure of how closely two assets move together, ranging from −1 (perfectly opposite) to +1 (perfectly in sync).
Formula
ρ(X,Y) = Cov(X,Y) / (σX × σY)
Correlation quantifies the relationship between two price series. A correlation of +1 means the assets move in perfect lockstep; −1 means they move in exactly opposite directions; 0 means no linear relationship.
For risk management, correlation is critical because holding highly correlated assets provides far less diversification than it appears. Five long positions in tech stocks may behave like one large tech position in a crash — all fall together.
Example
Correlation between AAPL and MSFT ≈ 0.85 historically. Holding both means your "two positions" move almost like one. To reduce correlated risk, pair them with an asset class that has correlation closer to 0 or negative.
Related Terms
Beta
A measure of a stock's volatility relative to the market. Beta > 1 means it moves more than the index; Beta < 1 means it moves less.
IntermediateHedging
Opening an offsetting position to reduce the net risk of an existing trade or portfolio against adverse price movements.
IntermediatePortfolio Heat
The total percentage of account capital currently at risk across all open positions simultaneously.
IntermediateSystematic Risk
Risk that affects the entire market or a broad asset class and cannot be eliminated through diversification.
IntermediateUnsystematic Risk
Company- or sector-specific risk that can be reduced through diversification across uncorrelated assets.
IntermediateValue at Risk (VaR)
The maximum loss not expected to be exceeded over a given time horizon at a chosen confidence level, e.g. 95% or 99%.
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