How Can You Calculate Correlation Using Excel?
Correlation is a statistical relationship that measures how related the
movement of one variable is compared to another variable. For
example, stock prices fluctuate over time and are correlated accordingly
or inversely to one another. Understanding stock correlation and being
able to perform analysis are very helpful in managing a stock portfolio
investment.
Understanding correlation and its applications in
stock investing
The most familiar correlation measure is the Pearson product-moment
correlation coefficient. The strength of the relationship between two variables
is expressed numerically between -1 and 1. For example:
Two stocks are positively correlated when their prices always go up or go
down together. Their coefficient is between (0, 1].
Two stocks are negatively correlated when one's price goes up while the
other goes down or vice versa. Their coefficient is between [-1, 0).
Two stocks are uncorrelated if their prices fluctuate independently of each
other. Their coefficient is then 0.
In stock investing, from the historical prices of stocks, investors can compute
the correlations between them in the past and predict their relationships in
the future.
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Based on historical correlations of one stock with a market index
or a commodity in terms of price, an investor might predict
whether the stock will go up or go down in response to a change
related to the index or the commodity.
Based on historical correlations of stocks, an investor might
reduce risk by diversifying a portfolio with stocks that are not
highly correlated.