In statistics, a correlation coefficient is used when determining the relationships between various sets of data. Consequently, it is also prevalent to compare multiple securities on a stock market and make decisions based on the relationship between the securities being compared. The correlation coefficient indicator brings a statistical measure when establishing a relationship between two financial instruments. The indictor uses either a series or a comparison mode when reflecting a correlation between multiple instruments.
As the indicator focuses on the correlations among the securities, it also uses a scale of 1 to -1 in measuring the correlations. Where the correlation coefficient is closer to 1, it implies that the relationship is stronger. On the other hand, the more the relationship is closer to -1, the more the relationship weakens. If the correlation coefficient shows a value of 0, it indicates no correlation between the securities in the discussion. (Try out indicators on Tradingview.com)
Features of the correlation coefficient
- Uses a scale of 1 to -1
- Uses either Comparisons or Series.
- Builds its decision on the positivity and negativity of securities relationships
- Use the first instrument when more than two securities are involved
- Calculated using closing prices
Calculations of Correlation Coefficient (CC) indicator
The spy and the JPM variances are first determined by the use of the closing prices. There is the freedom to determine the periods of the SPY and the JPM. The following steps are used.
- Determine the variances of the securities being compared
- Determine the co-variances of the securities, i.e., SPY and JPM
- Determine the correlation coefficient
Remember that the indicator is always at the heart of classical statistics. It will showcase the degree of the correlation of the securities being compared from a statistical perspective.
How the Correlation Coefficient (CC) indicator works
The bottom line is that the indicator is very impactful when making decisions based on comparable instruments by traders. With the indicator, there is a direct and simple interpretation that there is either a positive correlation or a negative correlation or no correlation between the instruments being evaluated.
Whenever the securities being evaluated are moving in the same direction, it is an indication that the correlation coefficient is positive. Consequently, when the instruments are in the opposite direction, the correlation is termed as negative.
How to trade with The Correlation Coefficient indicator
As is the case with statistical analysis, it is also essential to understand relationships between various securities of interest by traders. This is because security has some level of relationship. Their analysis is critical to investors, especially when making diversification decisions and recognizing securities with a low or negative correlation to the stock market.
Traders should also consider that although the Correlation Coefficiency (CC) is bounded between 1 to -1, it is not considered an oscillator. With the indicator, traders can align a positive portfolio with the correlation coefficient guide. For more insight about trading,
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