Overview
Correlation measures the relationship between two price series. A positive correlation means they tend to move in the same direction. A negative correlation means they tend to move in opposite directions. A low or near-zero correlation means there is no consistent relationship.
Correlations are not fixed. They can change quickly when the market regime changes, especially during risk-off periods, major macro repricing, or large event shocks.
What it means in practice
Correlation is often used to understand diversification, hedging, and cross-market relationships. If two instruments are highly correlated, holding both may not reduce risk as much as expected. If correlations change during stress, hedges may not behave the way they did in calmer periods.
Correlation can also be misleading if you look at the wrong timeframe. A relationship can appear strong over a month and weak over a day, or vice versa.
Why it matters in live markets
Correlations tend to rise during stress, which is why risk-off phases can feel like “everything moves together”. This can affect portfolio risk, stop behaviour, and execution outcomes because many participants are reacting at the same time.
Understanding correlation helps explain why a move in yields, credit spreads, or equities can spill into FX and commodities.
Key points
- Correlation is a relationship, not a cause.
- Correlations vary by timeframe and regime.
- Correlations often tighten during risk-off phases.
- Correlation breakdown is common around structural shifts, not just headlines.
Example
During a stable growth phase, equities and certain high-beta currencies may move together. During a sudden risk-off shock, correlations can tighten across many assets, and moves can become more uniform as participants reduce exposure at the same time.
Related glossary terms
Risk-On, Risk-Off, Sentiment, Risk Sentiment, Liquidity, Volatility, Positioning, USD Strength