Negative correlation, also known as an inverse correlation, is an important concept in the financial world. It describes the relationship between two variables in which one increases while the other decreases, and vice versa. While positive correlation – which is the opposite of negative correlation – implies that two variables move in the same direction, negative correlation perceives two variables as moving in opposite directions.

For example, a negative correlation may exist between oil prices and the value of the U.S. dollar. When oil prices rise, the value of the U.S. dollar typically goes down, and vice versa. Negative correlation is most often used in portfolio management as a way to reduce portfolio risk. Investing in assets that are negatively correlated with each other – such as stocks and bonds – can help protect investors against stock market volatility. A diversified portfolio that contains assets that are not generally correlated, such as stocks and bonds, is often called an optimal portfolio.

Negative correlation is also useful for hedging certain types of risk. For example, an investor with a large portfolio of stocks will benefit from investing in bonds as a sort of insurance policy. If the stock market crashes, the value of the bonds will provide some cushion against losses. Similarly, an investor with a large portfolio of bonds may benefit from investing in currencies, commodities, or other asset classes.

Negative correlation is not necessarily a guarantee, and correlation between two assets can change over time due to a variety of factors. That said, understanding how negative correlation works is an important component of portfolio management. By investing in assets that are likely to move in opposite directions, investors can benefit from price increases in one asset while protecting against losses in the other.