Trading Glossary
Correlation measures whether two positions tend to move together, move in opposite directions, or move independently of each other. It's expressed as a single number, the correlation coefficient, running from -1 to +1, and it's the number that tells you whether "two open positions" is really two separate bets or one bigger bet wearing two tickers.
A correlation of +1 means two instruments have moved in perfect lockstep historically: when one goes up 1%, the other has too. A correlation of -1 means they move in perfect opposite directions. A correlation of 0 means there's no historical relationship between their moves at all. Real-world pairs almost never sit exactly at one of those three points, but the closer a pair sits to +1 or -1, the more predictable their relationship to each other has been.
Position sizing rules are usually built around the idea that each trade is its own independent risk. Two highly correlated positions break that assumption. If a stock index fund and a handful of large-cap tech stocks all tend to rise and fall together, holding all of them at once isn't really diversification, it's closer to one large position sized as if it were several small ones. The same logic applies directly to forex: EUR/USD and GBP/USD are typically positively correlated, so a trader long both pairs at once is really doubling down on one broad view of the US dollar, not taking two independent trades.
A correlation coefficient is calculated from historical price data over some lookback window, and that number can and does shift over time. Two assets that normally move independently can suddenly become highly correlated during a sharp, broad selloff, when almost everything gets sold at once regardless of its usual relationships. That's exactly the moment correlation-based diversification tends to matter most and work least, which is why it's worth rechecking rather than assuming a past correlation still holds.
Traders use correlation mainly to catch hidden concentration: two or three positions that look diversified on paper but are actually one exposure. It's also used deliberately in hedging, pairing a position with a negatively correlated instrument so a move against one is partly offset by a move in the other. Either way, the number itself doesn't say a combination of positions is good or bad, it just tells you how independent those positions actually are before you decide how much total risk you're comfortable taking on.