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Correlation

Correlation is a statistical measure of the degree that two financial assets move in sync with each other. Correlation is always measured on a scale of -1 to +1. A correlation of 1.0 means that both assets move perfectly in sync. In other words, when asset A gains 2%, asset B also gains 2%. An example of highly correlated assets are car manufacturers and producers of tires.  If the correlation between asset A and B would be 0.5 it would mean that when asset A gains 2%, asset B gains 1%. An example of less correlated assets would be a company selling water bottles and a car manufacturer.

In terms of broad market indices, highly correlated assets are for example the S&P500 and the Nasdaq since both include stocks from the United States and are therefore mostly influenced by the same economic factors. An example of less correlated assets would be the S&P500 and Emerging Markets  since both indices are not influenced heavily by the same economic factors.

Correlation is important to look at when building a diversified portfolio. When building a portfolio investors should aim to include assets that are not heavily correlated with each other.

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