What does correlation between two stocks measure?

Correlation between two stocks measures how they move in relation to each other. A correlation coefficient ranges from -1 to +1. A coefficient of +1 indicates that the stocks move in perfect tandem; if one stock goes up, the other also rises proportionally. A correlation of -1 means the stocks move in opposite directions; when one stock increases in value, the other decreases. A correlation of 0 suggests that there is no predictable relationship between the price movements of the two stocks.

This concept is crucial in investment strategy and portfolio management as it helps investors understand the risk and diversification benefits of combining different assets. By knowing how assets correlate, investors can construct a portfolio that aims to reduce risk while still pursuing desired returns. Understanding these relationships can also aid in anticipating market behavior based on historical data.

The other options involve unrelated factors: dividends pertain to income rather than movement, price volatility indicates the range of stock price fluctuations but does not reflect the relationship between two stocks, and market capitalization refers to the total market value of a company's outstanding shares, which does not indicate how different stocks move relative to each other.