Risk and return · updated October 21, 2026
What is correlation between investments and how is it calculated
Correlation shows how closely two investments move in the same direction, on a scale from −1 to +1. At +1 they always rise and fall together, at 0 they have no link, at −1 they always move in opposite directions.
Correlation formula
- Covariance
- How much the returns of the two investments move together, at the same time.
- Standard deviation
- How much each investment moves on its own.
Worked example
Two bank stocks have a correlation of 0.85, a bank stock and gold 0.1, and stocks and government bonds have at times been at −0.3.
Two banks in the same portfolio do not protect each other. Gold or bonds can cushion a fall in stocks.
How to read correlation
Diversification works when you combine investments with low correlation. Ten stocks from the same sector, highly correlated with each other, behave almost like a single one.
When correlation can fool you
It changes in a crisis: when the market falls hard, almost all stocks start falling together, and correlations rise exactly when you need them to be low. It does not mean cause: two investments can be correlated without one affecting the other.
Related terms
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Questions about correlation
Why does correlation matter for a beginner?
Because it shows whether your portfolio is really diversified. What matters is how differently your investments move, not just how many you have.
What is the difference between correlation and beta?
Correlation only tells you whether two investments move together. Beta also tells you how much one moves relative to the other.
These explanations are for information only. They are not a recommendation to buy or sell.
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