![]() The Pearson correlation is the most common coefficient form and uses values between -1.0 and +1.0. There are four different statistical methods for calculating correlation coefficients:įor our interest today, we will focus on the Pearson correlation coefficient. No correlation – when there are zero relationships between the securities.Negative correlation – when the equity value of one security decreases with respect to the other security. ![]() Positive correlation – when the equity value of one security increases with respect to the other security.There are three types of correlation related to our interests: ![]() As the coefficients move closer to a positive one, the closer the correlation to the securities.Ī coefficient closer to a negative one indicates a negative correlation between the securities, with the increase in one stock tying to the other stock’s decrease. The idea of portfolio construction being the less correlated in our portfolio, the less risk involved, and the safer our investments.Ī stock correlation closer to zero, either positive or negative, implies little or no correlation between them. There are multiple methods of determining the correlation between those variables.įor our purposes, our interests lie in the correlation between two stocks, bonds, or ETFs.Ĭorrelations occur in the world of statistics, and we will dive into that world briefly to find a method for determining the riskiness of our portfolios. What Are the Five Types of Correlation?Ĭorrelation refers to the method of determining the relationship between two variables. And following the drawdown, stocks rebounded by 8%, and Treasuries fell during the rebound. For example, during the first half of 2008, U.S. Likewise, smaller-cap stocks such as Akero Therapeutics, Tupperware Brands, and Tootsie Roll positively correlate to the S&P 500, but it is lower, say 0.7, which means that small-cap stocks don’t move in parallel with the S&P 500.Īs mentioned earlier, stocks and bonds have a negative correlation. Some other examples to help illustrate the point: large-cap stocks such as Microsoft or Apple generally have a high positive correlation to the S&P 500, or nearly one. Bonds and stocks are thought to be in perfect negative correlation.Ī correlation of zero implies no relationship at all. Likewise, a perfect negative correlation means those two stocks move in opposite directions. A correlation coefficient of one equals a perfect positive correlation.įor stock correlations, a perfect correlation indicates that as one stock moves, either up or down, the other stock moves in tandem, in the same direction. And the correlation is expressed as a statistical coefficient.Īs mentioned above, the coefficient ranges between -1.0 and +1.0. Many advisors use stock correlations in the more advanced portfolios, and the calculations of the stock’s correlation have a value ranging between -1.0 and +1.0.Ĭorrelation, in statistics, shows the strength of the relationship between two variables. “Correlation, in the finance and investment industries, is a statistic that measures the degree to which two securities move in relation to each other.” Stock correlation, according to Investopedia, is defined as: Examples of Portfolios with Stock Correlation.How Do You Calculate the Stock Correlation?.What Are the Five Types of Correlation?.The theory is uncorrelated assets move in opposite directions for example, bonds do well when stocks perform poorly, and vice-versa. Many portfolio managers focus more on the assets and diversification than the actual securities. Investing using stock correlation helps avoid total portfolio meltdowns when a particular asset gets hurt. ![]() When constructing our portfolios, it is always best to invest in stocks, bonds, ETFS, or others not closely correlated. One way to determine a stock’s riskiness in your portfolio is to analyze your asset construction based on its stock correlation.īy looking at your portfolio’s correlation, you can identify too closely related assets, which can hurt your returns if that asset class is underperforming. “The possibility of permanent loss is the risk I worry about.”Īvoiding the possibility of losing money is Buffett’s number one rule, and many value investors subscribe to that idea, including yours truly.
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