Release
of Stock Correlation Coefficient Calculator
Today marks the initial release of the stock price correlation
calculator for this blog. You can access it by clicking on the “Correlation
Calculator” tab at the top of this page. Start with the quick start guide above
the calculator and you will be able to quickly start producing correlations and
standard deviations for five stocks at a time.
The objective here was to develop a correlation calculator that was
easy to use, generated a reliable result for five stocks at a time, and was
accompanied by a detailed description of how the calculations were done. There
is a detailed
description of how this blog’s calculator does its job towards the bottom of
the “Correlation Calculator” page. I recently did a survey of other stock
correlation coefficient calculators on the internet. There was almost a total
lack of description of how the correlations were generated and in some cases
results were produced that were either wrong or calculated using some other
definition of correlation.
Correlation coefficients between pairs of investments range from
-1 to +1. A value of +1 implies that when one stock price increases, the other
will increase an equal percent. A value of -1 implies that when one stock price
increases, the other will decrease an equal percent. A value of zero implies no
relationship between the two stocks.
For example, we would expect the S&P 500 Index to be highly
correlated to the Dow Jones Industrial Index and indeed it has a two year
correlation of .98. We also know that bonds are negatively correlated to stocks
and, for example, the S&P 500 Index and the Vanguard Total Bond Index ETF
(BND) have a negative two year correlation of -.61. This is also verified by
our recent experience with risk-on days where stock prices go up and bonds sell
off. Conversely, on risk-off days we see stocks sell off and bond prices go up.
The correlation coefficient will not help you identify investments
that have the potential for capital appreciation or high dividend payouts or
both. However, once you have identified investments that have high potential,
the correlation coefficients between them will help you identify what
investments from your list will zig while the others zag and, as a result, reduce
the total volatility of a portfolio. The ideal situation is that the majority
(or all) of the investments in a portfolio gain over the long term but, while
this is happening, the lack of correlation or negative correlation between the
individual investments reduces the volatility of the portfolio (and you sleep
better at night).
Investment Correlation Coefficients are the Rodney Dangerfield of
Modern Portfolio Theory statistics. They get no respect. While there is much
talk about an investment’s beta, alpha, standard deviation, and maybe r2,
there is little mention of the correlation coefficients between a pair of
investments. Yes, some articles will suggest an investment that is “not highly
correlated” with “the market” or “uncorrelated” with another stock. Still it is
rare to see actual numbers published.
I will be writing more about
correlation in the future including how it fits in with beta, alpha, standard
deviation, and r2. For now, enjoy trying out the new calculator!
