Correlation simply describes how two investments move in relation to each other, how tightly they are linked or opposed, meaning when one asset goes up, the other asset moves up, goes down or stays the same. It measures what generally happens to Asset A when Asset B\u2019s price changes. This is measured with a number called the correlation coefficient, which ranges between -1.0 (perfect negative correlation) and +1.0 (perfect positive correlation). Theoretically, a higher correlation means higher risk to the bottom line.<\/p>\n
If the markets fall, you don\u2019t want everything in your portfolio to fall at the same time. A better idea is to have some investments that move in opposite directions \u2013 or, are \u201cnegatively correlated.<\/p>\n
<\/span>What is positive correlation?<\/strong><\/span><\/h2>\nThe correlation coefficient of +1 is what is known as perfect positive correlation. Two perfectly correlated assets will move in the same direction \u2013 when one asset goes up, the other asset goes up.<\/p>\n
A simple analogy to describe positive correlation is: The more years of schooling you have, the higher your income will likely be. So, education and income tend to be highly positively correlated.What is negative correlation?<\/strong><\/p>\nPerfect negative correlation securities will move in opposite directions, and it is measured with the correlation coefficient of -1.0.<\/p>\n
A simple example of negative correlation is: The faster you drive the sooner you reach your destination. When the speed of your car increases, the time to your destination moves in the opposite direction \u2013 it decreases. So speed and \u201ctime to destination\u201d are negatively correlated.<\/p>\n
<\/span>What is no correlation?<\/strong><\/span><\/h2>\nA measure of 0.0 means the two assets move independent of one another. For example, there are no links between the price of mushrooms in Moscow, and the price of tea in Sri Lanka, hence, there\u2019s no relationship between the two.<\/p>\n
<\/span>How do market correlations work?<\/strong><\/span><\/h2>\nWith this in mind you\u2019ll see how market correlations work in interesting ways. For example, in August and September, the Chinese stock market fell 27%. During the same period the Hong Kong stock market declined 15%. You can see the relationship between the two over the past seven months in the chart below.<\/p>\n
![\"hangseng](\"https:\/\/static.imoney.my\/articles\/wp-content\/uploads\/2016\/02\/hangseng-vs-shanghai-800x493.png\")
<\/a><\/p>\nDuring this time, these two indices had a correlation coefficient of +0.93, which means they\u2019re positively correlated. The two markets generally move in the same direction at the same time. This makes a lot of sense, as China\u2019s and Hong Kong\u2019s economies and companies and politics are closely linked. This high level of correlation is an important thing to know if you\u2019re invested in both \u2013 if one falls, the other one probably will too.<\/p>\n
One way to protect your portfolio from market drops is to have holdings that have a low, or negative, correlation assets that don\u2019t move together. So when one asset falls, the other asset moves in the opposite direction, or, at least falls less.<\/p>\n
Now, let\u2019s have a look of how negative correlation looks like in the market. The chart below compares the Hang Seng Index to gold prices since 2011.<\/p>\n
Perfect negative correlation securities will move in opposite directions, and it is measured with the correlation coefficient of -1.0.<\/p>\n
A simple example of negative correlation is: The faster you drive the sooner you reach your destination. When the speed of your car increases, the time to your destination moves in the opposite direction \u2013 it decreases. So speed and \u201ctime to destination\u201d are negatively correlated.<\/p>\n
<\/span>What is no correlation?<\/strong><\/span><\/h2>\nA measure of 0.0 means the two assets move independent of one another. For example, there are no links between the price of mushrooms in Moscow, and the price of tea in Sri Lanka, hence, there\u2019s no relationship between the two.<\/p>\n
<\/span>How do market correlations work?<\/strong><\/span><\/h2>\nWith this in mind you\u2019ll see how market correlations work in interesting ways. For example, in August and September, the Chinese stock market fell 27%. During the same period the Hong Kong stock market declined 15%. You can see the relationship between the two over the past seven months in the chart below.<\/p>\n
<\/a><\/p>\nDuring this time, these two indices had a correlation coefficient of +0.93, which means they\u2019re positively correlated. The two markets generally move in the same direction at the same time. This makes a lot of sense, as China\u2019s and Hong Kong\u2019s economies and companies and politics are closely linked. This high level of correlation is an important thing to know if you\u2019re invested in both \u2013 if one falls, the other one probably will too.<\/p>\n
One way to protect your portfolio from market drops is to have holdings that have a low, or negative, correlation assets that don\u2019t move together. So when one asset falls, the other asset moves in the opposite direction, or, at least falls less.<\/p>\n
Now, let\u2019s have a look of how negative correlation looks like in the market. The chart below compares the Hang Seng Index to gold prices since 2011.<\/p>\n
With this in mind you\u2019ll see how market correlations work in interesting ways. For example, in August and September, the Chinese stock market fell 27%. During the same period the Hong Kong stock market declined 15%. You can see the relationship between the two over the past seven months in the chart below.<\/p>\n
During this time, these two indices had a correlation coefficient of +0.93, which means they\u2019re positively correlated. The two markets generally move in the same direction at the same time. This makes a lot of sense, as China\u2019s and Hong Kong\u2019s economies and companies and politics are closely linked. This high level of correlation is an important thing to know if you\u2019re invested in both \u2013 if one falls, the other one probably will too.<\/p>\n One way to protect your portfolio from market drops is to have holdings that have a low, or negative, correlation assets that don\u2019t move together. So when one asset falls, the other asset moves in the opposite direction, or, at least falls less.<\/p>\n Now, let\u2019s have a look of how negative correlation looks like in the market. The chart below compares the Hang Seng Index to gold prices since 2011.<\/p>\n![\"hangseng](\"https:\/\/static.imoney.my\/articles\/wp-content\/uploads\/2016\/02\/hangseng-vs-shanghai.png\")
<\/a><\/p>\n