Correlation: why diversification sometimes stops working
beginner
Automated material · TradeAlmanac editorial deskDraft prepared by a language model from our stored data; not reviewed by an editor.
Diversification rests on assets behaving differently. The measure of that difference is correlation.
How it works
Assets that move out of step damp each other's swings.
{{figure:correlation|caption=A portfolio of assets moving out of phase fluctuates less than either of them separately}}
The main caveat
Correlations are not constant. In calm times assets diverge; in a crisis they converge: everything is sold at once because money is needed.
How to account for it
Do not treat historical correlation as a constant. Check what happens if it rises to one — that is, if everything falls together.
Separate sources of risk rather than names of assets: two securities from different sectors that depend on the same factor create a false sense of variety — Sectors of the Russian market: what it is made of.
What genuinely diverges
Assets with fundamentally different sources of income: equities live on company profits, bonds on interest payments, gold has no cash flow at all.
That is exactly why allocating across classes is more effective than allocating within one — Asset allocation: the decision that shapes everything else.
And a separate class
Infrastructure risk obeys no correlation at all: it materialises simultaneously for everything recorded through the same chain — Restrictions and infrastructure risk: how it differs from market risk.
Related: Diversification: what it gives and what it does not.
Draft prepared by a language model from our stored data; not reviewed by an editor.
Model: claude-opus-5
How we use language modelsSimilar articles
- The secondary market for DFAs: why the asset never leaves its own platformA DFA can be sold before redemption only inside the platform where it was issued, and only through an exchange operator listed in the Bank of Russia register. Why the asset cannot be moved to another operator, how selling it differs from placing an order in a bond's order book, and what the sale changes in the purchase limit and in the tax.
- Terms of Trade: How the Ratio of Export to Import Prices Moves the Rouble and ProfitsThe terms of trade are the ratio between the prices at which a country sells its exports and the prices at which it buys its imports.
- TWAP order: the algorithm slices volume by time, not by liquidityA TWAP order (time-weighted average price) is an instruction to the trading system: take a large order, break it into a stream of small child orders and release them in equal portions at equal intervals until the end of a set window.
- The Impossible Trinity: What a Central Bank Pays for a Fixed Exchange RateThe impossible trinity is the proposition that, out of the set of goals "fixed exchange rate", "free movement of capital" and "independent interest rate", a state can hold any combination except the complete set.