What is correlation, really?
An intuitive understanding of how assets move together, positive and negative correlation, and why it matters for diversification.
Play with it
Correlation and covariance. Dial a correlation from −1 to +1 and watch two assets move together, apart, or not at all.
Same pattern, measured in bigger units.
Measured correlation+0.66always between −1 and +1
Covariance10.5changes with scale
120 monthly returns, one dot per month
The same two assets as prices over ten years
These two assets move strongly in the same direction, with a measured correlation of 0.66. Now drag the scale dial and watch which number changes.
Try this
- Set correlation to +1: the two friends always walk in the same direction.
- Set it to −1 and watch the dots line up like a seesaw.
- Set it to 0. Knowing asset A's month tells you nothing about asset B's.
- Scale asset B by 100×. The covariance explodes, the correlation stays put.
The math
- correlation, from −1 to +1
- covariance, in the data's own units
- each asset's standard deviation
Quick check
Two questions to see if it clicked. Answers explain themselves.