Correlation
Correlation measures how closely two investments move together, on a scale from -1 (opposite directions) through 0 (unrelated) to +1 (perfectly in step).
A correlation of +1 means two assets always move in the same direction in proportion; -1 means they always move in opposite directions; 0 means there is no consistent linear relationship. Most real pairs fall somewhere in between. Stocks within the same industry often show high positive correlations.
Correlation is the key to diversification. Combining assets with low or negative correlation can reduce a portfolio's overall volatility without necessarily reducing its expected return. This is why stocks and high-quality bonds are often paired: in many periods, bonds have held up when stocks fell.
Correlations change over time. During market crises, many risky assets tend to fall together and correlations rise, just when diversification is most wanted. Stocks and bonds have also moved in the same direction at times, for example when inflation and rising rates hurt both.
Correlation does not imply causation, and it only captures linear relationships. Example: two stocks with a correlation of 0.9 have historically tended to rise and fall on the same days.