Why Should You Care About Correlations?

There are plenty of statistics that you can use to inform your decision to invest in a particular company, currency, or sector. Whatever your metrics, investing can remain a very human and intuitive decision! You should have confidence in what you're investing in, and CorrelatePro hopes to give you the tools to make the best decision possible— and correlations are just one part of the equation.

What is a Correlation?

So what is correlation, and why should you care about it? A pair of stocks that are perfectly correlated (a correlation coefficient of 1) maintain the same slope— increases and decreases— over time. In some instances, this might indicate a similar dependency: company A might use the same resources as company B, for example. If this statistic is perfectly negative (a value of -1), then if company A increases +2.23% in a single day company B would decrease -2.23% over the same period of time. Similarly, a correlation value of 0 means that the two stocks have completely unique behaviors over time, or even high volatility.

Correlations and Cryptos

So what can you do with this? Let's take a look at the recent cryptocurrency craze. Many financial experts have attested to the risks associated with investing in cryptocurrencies. Take a quick look at a CorrelatePro portfolio and populate it with some popular cryptos, and set Bitcoin (BTC) as the central node. You can toggle displaying the value of correlations between BTC and the other cryptos on or off by clicking that center circle. You'll see that most other coins have a significantly high correlation coefficient, 0.75 or higher when I last checked. This shows that their behavior (relative increases or decreases over time) is quite similar. If all your cryptocurrencies are doing well, this could result in some outstanding returns. However, at the same time, this isn't a diverse portfolio. If one crypto starts to lose, there is statistical evidence to indicate that the others will behave the same way.

Are Correlations the Best Metric?

Rick Ferri, a Forbes contributor, wrote a piece that curbed the importance of correlations in investment analysis. But really what he's saying is that you shouldn't rely only on correlations for determining asset allocation, and he's right! There are a lot of variables that determine how a stock or other investment will behave: media coverage, dynamic resources, etc. Additionally, you might recall the common adage: "correlation does not equal causation". Just because company A and company B have shown consistent rise and fall on the market in the past, that doesn't mean that they will continue that way in the future. Smart investors draw upon a myriad of data and sources to predict how their portfolio will perform, but correlations can be a foundational statistic for beginning that analysis.

Conclusion

Correlations, therefore, can be a solid metric for diversifying your portfolio and mitigating risk— or, perhaps, riding an early bull market with related stocks. However, it's one of a number of other variables that an investor looks at in making accurate speculations on the outcome of their investments. We're working on more tools and features to make CorrelatePro an incredible resource for you to gain a holistic understanding of your investments. Is there something you'd like to see? Sign in to leave us some feedback! Curious about how your portfolio looks? Sign up for CorrelatePro today and start investment planning with confidence!

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