Correlation
Correlation measures how two markets move together, from +1 (identical) to -1 (opposite), and decides whether positions are actually diversified.
Correlation measures how two markets move together, from +1 to -1. Correlated pairs are one position in disguise, and correlations converge toward one in crises.
Correlation measures the degree to which two instruments move together, from +1 (move identically) to -1 (move in exact opposition), with zero meaning no relationship. EUR/USD and GBP/USD are strongly positively correlated; EUR/USD and USD/CHF are strongly negatively correlated. Correlation matters because it exposes fake diversification: a portfolio of six correlated pairs is one position with six times the risk. Correlations are not stable, and they converge toward one in crises.
How It Works
- Range from +1 (same direction) to -1 (opposite)
- EUR/USD vs GBP/USD strongly positive; vs USD/CHF strongly negative
- Shifts over time and spikes toward 1 in stress
Trading Tips
Size correlated positions as one combined risk
Check correlation before calling a basket diversified
In a crisis, hedges you thought were hedges move together
Related Terms
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