Correlation Coefficient

What It Measures

• Ranges from minus 1 to plus 1.
• Plus 1 equals perfect positive correlation moving together.
• Zero equals no relationship.
• Minus 1 equals perfect negative correlation moving in opposite directions.
• Measures strength and direction of relationship between two assets.

Institutional Use

• Used for portfolio construction, risk management, and hedging, not prediction.
• Rolling correlation is used because relationships change over time and across market regimes.

Key Signals

• Correlation moving toward plus 1 across assets signals risk-on convergence and diversification failing.
• Correlation breakdown signals regime shift or stress event.
• Negative correlation between assets represents genuine diversification.

Trading Playbook

• Portfolio construction: combine assets with low or negative correlation.
• Stress testing: model how correlations shift during drawdowns.
• Relative value: identify pairs with historically stable correlation that has temporarily broken down.

When Not to Trade

• Avoid assuming static correlations.
• During macro stress events, correlations often converge toward plus 1, eliminating expected diversification benefits.