In finance, correlation describes how strongly two assets, markets, or instruments move in relation to each other. It is expressed as a correlation coefficient on a scale from -1 to +1.
A correlation of +1 indicates a perfect positive relationship, meaning both assets move in the same direction. A correlation of -1 indicates a perfect inverse relationship, where one asset rises while the other falls. A value of 0 indicates no linear relationship.
Correlation is a key metric in portfolio construction and diversification. Assets with low or negative correlation can offset each other and reduce overall portfolio risk.
However, correlation is not static—it changes over time and can increase sharply during periods of market stress, which can reduce the effectiveness of diversification.
In wealth management, correlation is regularly monitored and considered when adjusting asset allocation.
