Feature Correlation

Correlation statistically measures the degree of relationship between two variables in terms of a number that lies between +1.0 and -1.0. When it comes to diversified portfolios, correlation represents the degree of relationship between the price movements of different assets included in the portfolio. A correlation of +1.0 means that prices move in tandem; a correlation of -1.0 means that prices move in opposite directions. A correlation of 0 means that the price movements of assets are uncorrelated; in other words, the price movement of one asset has no effect on the price movement of the other asset.

In actual practice, it's difficult to find a pair of assets that have a perfect positive correlation of +1.0, a perfect negative correlation of -1.0 or even a perfect neutral correlation of 0. A correlation between different pairs of assets could be any one of the numerous possibilities lying between +1.0 and -1.0 (for example, +0.62 or -0.30). Each number thus tells you how far or how close you are from that perfect 0 where two variables are uncorrelated. So, if the correlation between Asset A and Asset B is 0.35 and the correlation between Asset A and Asset C is 0.25, then you can say that Asset A is more correlated with Asset B than it is with Asset C.

If two pairs of assets offer the same return at the same risk, choosing the pair that is less correlated decreases the overall risk of the portfolio.