Last Updated on 3 November, 2022 by Samuelsson
Correlation is a mathematical term that measures the relationship between two variables or datasets.
For example, the height of children tends to correlate to the height of the parents. Likewise, we have a correlation in trading. For example, the price of oil tends to correlate with the Norwegian krona, Airline stocks react negatively to a price rise in oil, and a rise in interest rates is negative for stocks. Understanding correlation in trading is important to improve your profits and losses.
Correlation in trading measures how your trading strategies perform together. If you have losses in one strategy, you obviously prefer not to have losses in all the other strategies at the same time.
There is no point in having, for example, ten different strategies if they correlate 80% of the time. If you lose money in strategy 1, you most likely also lose in the other nine strategies (at the same time) if the correlations are high.
Sadly, correlations are not static and go up and down. In a market panic, many strategies tend to correlate more – exactly at the moment when you need correlation the most. Furthermore, it’s hard to predict and forecast correlations.
More Reading in the topic: What Does Correlation Mean In Trading? (Trading Strategies And Correlations)