Correlation
#CryptoNews #cryptocurrencies #risks #riskmanagement
Pearson correlation heatmap below covers over 20+ different
Pearson correlation heatmap below covers over 20+ different #cryptocurrency pairs weekly averaged
Colormap blue >0.8, yellow <0.2, orange <-0.1
High correlation spec interdependence
Low/neg corr buy predict LINK DASH XMR
Colormap blue >0.8, yellow <0.2, orange <-0.1
High correlation spec interdependence
Low/neg corr buy predict LINK DASH XMR
What Is Correlation?
- Correlation is a statistic that measures the degree to which two variables move in relation to each other.
- In finance, the correlation can measure the movement of a stock with that of a benchmark index, such as the S&P 500.
- Correlation measures association, but doesn't show if x causes y or vice versa—or if the association is caused by a third factor.
What Correlation Can Tell You
Correlation shows the strength of a relationship between two variables and is expressed numerically by the correlation coefficient. The correlation coefficient's values range between -1.0 and 1.0.
A perfect positive correlation means that the correlation coefficient is exactly 1. This implies that as one security moves, either up or down, the other security moves in lockstep, in the same direction. A perfect negative correlation means that two assets move in opposite directions, while a zero correlation implies no linear relationship at all.
For example, large-cap mutual funds generally have a high positive correlation to the Standard and Poor's (S&P) 500 Index or nearly one. Small-cap stocks tend to have a positive correlation to the S&P, but it's not as high or approximately 0.8.
However, put option prices and their underlying stock prices will tend to have a negative correlation. A put option gives the owner the right but not the obligation to sell a specific amount of an underlying security at a pre-determined price within a specified time frame.
Put option contracts become more profitable when the underlying stock price decreases. In other words, as the stock price increases, the put option prices go down, which is a direct and high-magnitude negative correlation.
What Is Meant by the Correlation Coefficient?
The correlation coefficient describes how one variable moves in relation to another. A positive correlation indicates that the two move in the same direction, with a +1.0 correlation when they move in tandem. A negative correlation coefficient tells you that they instead move in opposite directions. A correlation of zero suggests no correlation at all.
What Is Positive Correlation?
A positive correlation is a relationship between two stocks that move in tandem—that is, in the same direction. A positive correlation exists when one stock decreases as the other stock decreases, or one stock increases while the other increases
Beta and Correlation
Beta is a common measure of how correlated an individual stock's price is with the broader market, often using the S&P 500 index as a benchmark. If a stock has a beta of 1.0, it indicates that its price activity is strongly correlated with the market. A stock with a beta of 1.0 has a systematic risk, but the beta calculation can’t detect any unsystematic risk. Adding a stock to a portfolio with a beta of 1.0 doesn’t add any risk to the portfolio, but it also doesn’t increase the likelihood that the portfolio will provide an excess return.
A beta of less than 1.0 means that the security is theoretically less volatile than the market, meaning the portfolio is less risky with the stock included than without it. For example, utility stocks often have low betas because they tend to move more slowly than market averages.
A beta that is greater than 1.0 indicates that the security's price is theoretically more volatile than the market. For example, if a stock's beta is 1.2, it is assumed to be 20% more volatile than the market. Technology stocks and small caps tend to have higher betas than the market benchmark. This indicates that adding the stock to a portfolio will increase the portfolio’s risk, but also increase its expected return.
Some stocks even have negative betas. A beta of -1.0 means that the stock is inversely correlated to the market benchmark as if it were an opposite, mirror image of the benchmark’s trends. Put options or inverse ETFs are designed to have negative betas, but there are a few industry groups, like gold miners, where a negative beta is also common.
Positive Correlation vs. Inverse Correlation
In statistics, positive correlation describes the relationship between two variables that change together, while an inverse correlation describes the relationship between two variables which change in opposing directions. Inverse correlation is sometimes described as negative correlation. Examples of positive correlations occur in most people's daily lives. The more hours an employee works, for instance, the larger that employee's paycheck will be at the end of the week. The more money is spent on advertising, the more customers buy from the company.
Inverse correlations describe two factors that seesaw relative to each other. Examples include a declining bank balance relative to increased spending habits and reduced gas mileage relative to increased average driving speed. One example of an inverse correlation in the world of investments is the relationship between stocks and bonds. As stock prices rise, the bond market tends to decline, just as the bond market does well when stocks are underperforming.
Example
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