What are the types of correlation between stocks?
When it comes to stocks, stocks can have a variety of different correlations with other stocks. Correlation refers to how one stock moves relative to another stock or an industry/sector. So when you hear the term correlation, think about if one stock goes up, will the other stock go up or down. In order to assess correlation, multiple data points for each stock would be plotted to see what the correlation is.
Below is the four main types of correlation:
Perfectly correlated (+1): When stocks are perfectly correlated, that means the two stocks move up and down exactly the same amount. So in the visual above, if stock E goes up 5%, then stock F would also go up 5%. If stock F goes down 5%, then stock E would also go down 5%. This combination presents high risk and high reward for investors.
Positively correlated: When stocks are positively correlated, that means the two stocks move up and down together. So in the visual above, if stock H goes up 5%, then stock I might go up 3%. If stock I goes down 3%, then stock H might go down 5%.
Perfectively negatively correlated (-1): When stocks are perfectly negatively correlated, then the two stocks move in opposite directions by the exact same amount. So in the visual above, if stock L goes up 5%, then stock M would go down by 5%. If stock M goes up 5%, then stock L would go down 5%. This correlation presents the least amount risk but also the lowest amount of upside for investors.
Negatively correlated: Negatively correlated means that the stocks move in opposite directions. So if stock P goes up by 5%, then stock O might go down by 3%. If stock O goes up 5%, then stock P might go down 3%
Stocks can also have no correlation, which means there is no pattern or trend.
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