Stock Market · Risk Management & Psychology

Correlation

Correlation measures how closely two assets move together. A correlation of +1.0 means they move in lockstep. -1.0 means they move opposite. 0 means independent. Understanding correlations is the difference between real and fake diversification.

Common correlations Indian investors miss

• Bank Nifty and Nifty 50: correlation > 0.85. Heavy bank holdings push them together
• Indian equity and US equity: correlation ~0.6-0.7. FII flows link them
• Gold and equity: typically -0.2 to +0.2. Partial hedge but not perfect
• Crude oil and Nifty: usually -0.3, inverse relationship
• USD/INR and Nifty: -0.4 to -0.6. Rupee weakens when Nifty falls

The crisis correlation trap

In normal markets, correlations between asset classes are moderate. In crisis periods, correlations spike toward +1.0, everything falls together.

March 2020: Nifty fell 40%, gold initially fell 10% (later recovered), debt funds with credit exposure also fell. Even 'diversified' portfolios suffered.

> True diversification requires assets that maintain low correlation EVEN IN CRISES. Government bonds and gold come closest. Cash is the ultimate uncorrelated asset.

Sector correlations

Strong positive correlation (avoid combining for diversification):

• IT companies (TCS, Infosys, HCL): correlation > 0.85
• PSU banks (SBI, PNB, BOB): correlation > 0.9
• Cement companies: correlation > 0.8

Low correlation (better diversifiers):

• IT and pharma: 0.3-0.5
• Equity and government bonds: -0.1 to 0.2

Tools

Several broker consoles and portfolio analytics tools render a correlation matrix for your holdings, which is the fastest way to spot two positions that are really one bet.

Takeaway. Correlation measures co-movement: +1 = lockstep, 0 = independent, -1 = opposite. Sector stocks have correlation > 0.85, not real diversification. In crises, correlations rise toward 1.0. Use uncorrelated asset classes, not just multiple stocks.