In the March 1952 issue of Journal of Finance, Harry M. Markowitz published an article titled Portfolio Selection. In the article, he demonstrates how to reduce the risk of asset portfolios by selecting assets whose values aren't highly correlated. At the same time, he laid down some basic principles for establishing an advantageous relationship between risk and return. This has come to be known as diversification of assets. In other words, don’t put all your eggs in one basket.

A key to understanding the Markowitz model is to be comfortable with the statistic known as the variance of a portfolio. Mathematically, the variance of a portfolio is:

∑i∑j Xi Xj σi,j

where,

Variance is a measure of the expected fluctuation in return—the higher the variance, the riskier the investment. The covariance is a measure of the correlation of re­turn fluctuations of one stock with the fluctuations of another. High covariance indicates an increase in one stock’s return is likely to correspond to an in­crease in the other. A covariance close to zero means the return rates are relatively inde­pendent. A negative covariance means an increase in one stock’s return is likely to correspond to a decrease in the other.

The Markowitz model seeks to minimize a portfolio's variance, while meeting a desired level of overall expected return.