Correlation

In one of my earlier I had mentioned about Correlation to avoid market risk. Correlation is nothing but the relation between any two entities. For example there can be correlation between gold prices and stock conditions or monsoon and rural consumption.
Correlation is measured by the correlation co-efficient. A positive correlation coefficient indicates that both values move in same direction, while a negative indicates it moves in opposite direction.
The maximum absolute value of correlation is 1. A value closer to 1 indicates strong correlation while value closer to 0 shows weak. +1 shows that the value move in perfect tangent, while -1 shows that the values move in exactly the opposite direction by equal amounts.
Correlation is the key to effective diversification. It is better to have a good set of 10-20 companies at max in your portfolio. It is important to not only diversify in stocks, but also in asset classes.

Know the risks in your investment

Risks in investment are of two types- namely market risk ( also called systematic risk) and company - specific risk ( called unsystematic risk ). Market risk is induces by market forces, which are external to the company.
Company specific risks are induced by factors internal to the company.
In short, systematic risk affects all businesses in that particular sector while company specific risk affects only the company in question.
Market risk are too difficult to predict but it can be possible to diversify the company specific risk and allocate the investment across various other companies. Allocations will help reduce the risk that parking all the investment in one company or a small set of companies induces. This is to ensure that prices of all the companies do not move up or down at the same time. It can be done by only one way and that's called "Correlation".