Understand investment products, market mechanics, indicators and research terminology. Each entry includes an explanation, example, cautions and related learning.
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Correlation is a statistic between −1 and +1 that measures how closely two return series move together in a straight-line sense. A value of +1 means they move in perfect step, 0 means no linear relationship, and −1 means they move in exactly opposite directions.
Diversification is spreading capital across holdings whose returns do not move in perfect step, so that the combined portfolio is less volatile than the weighted average of its parts. It mainly reduces risks specific to one company, sector or asset.
Drawdown is the percentage decline of an investment, account or strategy from its previous peak value to a later low. Maximum drawdown is the largest such peak-to-trough fall over a chosen period.
Leverage is the use of borrowed money or derivative contracts to hold market exposure larger than the capital you put up, which magnifies both gains and losses relative to that capital.
Margin is the collateral a trader must deposit with a broker or clearing house to open and maintain a leveraged position, such as a futures contract, a margin loan or a short sale. It is a performance deposit against potential losses, not a fee and not the maximum amount that can be lost.
Position sizing is the rule that decides how many units of an instrument to hold in a single position. A common approach is fixed-fractional sizing, which sets the size so that the loss to a planned exit price equals a chosen percentage of account equity.
The Sharpe ratio measures a portfolio's average return above the risk-free rate per unit of total volatility. It was introduced by William Sharpe to compare risk-adjusted performance across strategies.
The Sortino ratio is a variation of the Sharpe ratio that divides excess return by downside deviation, which counts only returns below a chosen minimum acceptable return (MAR). It penalizes harmful volatility rather than all volatility.
Value at Risk is a loss threshold for a portfolio over a set horizon, estimated so that losses are expected to exceed it only with a small stated probability, such as 5%. A 95% one-day VaR of HK$20,000, for example, means a loss larger than HK$20,000 is expected on about 1 day in 20 under the model's assumptions.
Volatility measures how widely an asset's returns vary around their average, most often as the standard deviation of returns, usually quoted as an annualized percentage. Higher volatility means larger price swings in both directions, not a particular direction.