Unit 1 · Level 3 · Risk-on / risk-off
Correlations by regime
In calm markets, stocks, bonds, property and gold wander their own paths, and diversification feels magical. In panics, they herd: in 2008 stocks, property, commodities and corporate bonds all fell together. High-quality government bonds were among the few shelters that held up. The Investing course gave you the grim trader saying: 'in a crisis, correlations go to one.' Diversification helps most in normal times, least at the exact moment you want it most.
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What you get asked
Two assets have a correlation close to +1. That means:
+1 is lockstep, 0 is unrelated, −1 is mirror image. Diversification only works when your assets are NOT near +1. Correlations also change with the regime.
In the 2008 crash, which asset class actually held up?
Almost everything risky fell together in 2008 (the S&P dropped 57% peak to trough) while top-grade government bonds were among the few genuine shelters.
Order the chain of a panic-driven correlation spike
In a panic, selling is about raising cash, not fundamentals. Even 'uncorrelated' assets get dumped by the same desperate sellers.
Traders' grim rule: in a crisis, correlations go to ___.
Correlation of one means everything moves together. That is exactly what deep panics tend to produce, however diversified you felt beforehand.
The honest conclusion about diversification:
Still worth doing, because most of your investing life happens in normal times. Just don't mistake it for crash insurance. 🐜
The rest of this unit
Markets have two moods. Learn what rallies, what hides, and how fast the switch flips.