Covariance can increase diversification in the asset portfolio.
However, including more assets with negative covariance means that risk decreases more quickly.
While covariance can show the trend between two assets, it cannot be used to calculate the strength of the relationship between prices.
An additional disadvantage of using variance is that the measurement is subject to skew due to the presence of outliers in the underlying data.
Thus, large price movements in one period may skew the general volatility of the price chain and provide an unreliable statistical measure of the nature of the trend among assets.https://www.freeforex-signals.com/Use of the modern portfolio theory of heterogeneityModern portfolio theory (MPT) uses covariance as an important component in constructing portfolios.
MPT assumes that investors are risk averse yet still seek the best possible return.