DEFINITION of 'Cluster Analysis'
An investment approach that places securities into groups based on the correlation found among their returns. Securities with high positive correlations are grouped together and segregated from those with negative correlation. Between each cluster, very little correlation should exist. Holding stocks in each cluster provides the investor with a diversified portfolio.
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BREAKING DOWN 'Cluster Analysis'
Cluster analysis enables the investor to eliminate any overlap in his or her portfolio by identifying securities with related returns. This approach increases diversification, which provides the investor will a less risky portfolio. Cluster analysis has uncovered certain categories of stocks, such as cyclical and growth stocks.
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RELATED FAQS

What is a common strategy traders implement when using Fibonacci Clusters?
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Does a negative correlation between two stocks mean anything?
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How do fund managers use correlation to create portfolio diversity?
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How is correlation used differently in finance and economics?
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