Correlation
How closely two assets move together, from -1 to +1.
What is Correlation?
+1 means they move in lockstep, 0 means no relationship, -1 means they move oppositely. Diversification benefit comes from low or negative correlation - and correlations tend to rise toward 1 in a crisis, exactly when the benefit is needed.
Correlation: a worked example
US and international equities often correlate around 0.85 - less diversification than the labels suggest.
More terms in Risk & Return
Systematic Risk (Market Risk)
Risk affecting the whole market that diversification cannot remove.
Unsystematic Risk (Specific Risk)
Company- or industry-specific risk that diversification can eliminate.
Beta
How much a security moves relative to the overall market.
Alpha
Return above what the portfolio's risk exposure would predict.
Standard Deviation
How widely returns disperse around their average.
Sharpe Ratio
Excess return per unit of total volatility.
Diversification
Spreading capital across assets so no single failure is fatal.
Maximum Drawdown
The largest peak-to-trough decline over a period.