A negative, or 澳洲幸运5开奖号码历史查询:inverse correlation, between two variables, indicates that one variable increases while the other decreases, and vice versa. This relationship may or may not represent causation between the two variables, but it does describe an observable 🍸pattern.

A negative correlation can be contrasted with a 澳洲幸运5开奖号码历史查询:positive correlation, which occ❀urs when two variables tend to move in tandem.

Understanding negative correlation is important for investors since including assets in a portfolio that tend to move in opposite🍨 directions is key to achieving a well-diversified portfolio.

In fact, it is because some asset classes—for instance, stocks and bonds—tend to exhibit a negative correlation with each other that 澳洲幸运5开奖号码历史查询:diversification can increase expected returns while at the same time reducing overall portfolio risk.

Here, we dig deeper into how correlation is calculated and why negatively correlated assets work together to produce a net positive, as oppose🎉d to simply canceling each other out, for investors.

Understanding Negative Correlation

When two variables are correlated, the rela༒tive changes in their 🤡values appear to be linked. This pattern may be the result of the same underlying cause or could be pure coincidence. It is thus important to recognize the adage “correlation does not imply causation.” Nevertheless, correlation is an important statistical tool used to measure the strength of a relationship between two or more variables.

This measure is expressed numerically by the 澳洲幸运5开奖号码历史查询:correlation coefficient, sometimes denoted by “r” or the Greek letter rho (ρ). T🌌he values assigned to the correlation coefficient✤s range from -1.0 and 1.0.

A “perfect” positive correlation of +1.0 would mean that two variables move exactly in lockstep with one another—so if variable A increases by two, so does variable B. A “perfect” 澳洲幸运5开奖号码历史查询:negative correlation of -1.0, by contrast, would🐽 indiဣcate that the two variables move in opposite directions with equal magnitude—if A increases by two, B decreases by two.

In reality, very few factors are perfectly correlated either way, and the correlation coefficient will fall somewhere within the negative-one-to-one range. Note that a correlation of zero suggests that there is no relationship between two variables and their movements are completely unrelated or random to one anothe🅠r.

Negative correlations occur naturally in many contexts. For instance, as the amount of snowfall increases, fewer drivers appear on the road. Or, as a cow gets older, her milk production drops. As you exercise more, you tend to lose weight. The more cats there are in a neighborhood is related to fewer mice. Negative correlations also appear in the 🌼world of economics and finance.

$\begin{aligned}&r=\frac{\sum(X-\overline{X})(Y-\overline{Y})}{\sqrt{\sum(X-\overline{X})^2}\sqrt{(Y-\overline{Y})^2}}\\&\textbf{where:}\\&r=\text{The correlation coefficient}\\&\overline{X}=\text{The average of observations}\\&\qquad\text{ of variable }X\\&\overline{Y}=\text{The average of observations}\\&\qquad\text{ of variable }Y\end{aligned}$​r=∑(X−X)2​(Y−Y)2​∑(X−X)(Y−Y)​where:r=The correlation coefficientX=The average of observations of variable XY=The average of observations of variable Y​

How Investors Use Correlations

Investors can appreciate the concept of negative corr🅺elation simply by identifying two stocks that appear to be negatively correlated.

For instance, if stock A tends to fall when stock B rises, an investor who owns both shares would see the losses in🌠 one offset by gains in the other. The two stocks may be negatively correlated because they experience some negative feedback from one ꧒another directly, or because they react differently to the same external stimuli.

In the first case, imagine two compe🧜titors, such as Coca-Cola and PepsiCo. Because these two firms are locked in a perpetual battle for market share in the beveragesꦡ sector, what is good for Coca-Cola may necessarily be bad news for Pepsi and vice versa.

A great new prod💙uct by Pepsi may boost its share price while Coke falls. Therefore, close compe💃titors in highly competitive markets may have a negative correlation.

In the second case, the two stocks may naturally react to the same external or indirect cause in an ಌopposite fashion. For instance, financial stocks such as banks or insurance companies tend to get a boost when interest rat🎃es rise, while the real estate and utilities sectors get hit particularly hard given the same news.

Many investors study 澳洲幸运5开奖号码历史查询:correlations between stocks, as well as between industries, geographies, and asset types. For example, an investor in oil might hedge a portfolio with stocks in a𝓰irlines. The two industries have a negative correlation.

When oil prices slide, airline stocks rise. Adding more negatively correlated assets to a portfolio is the foundation of the concept of diversification. 澳洲幸运5开奖号码历史查询:Modern portfolio theory (MPT), the formative theory behind portfolio diversification, points out that combining risky assets does not necessarily dictate that the overall portfolio risk will increase so long as there are negative correlations among them.

Negative Correlation Between Stocks and Bonds

One of the most widely recognized negative correlations among asset classes is that of stocks and bonds. Traditionally, financial experts 𝐆have recommended owning both stocks and bonds with weights that vary with investment goals, time horizon, and risk tolerance. The reason behind holding both stocks and bonds is that when stocks fall, bonds ♓tend to rise. This generates a risk reduction through diversification.

Why are stocks and bonds thought to be negatively correlated? The theory posits that inflation, which is a general rise in prices, benefits stock prices because increased costs will be passed on to consumers and🍰 translate into greater nominal profits.

Bonds, on the other hand, which often pay a fixed interest rate, w🃏ill see the value of those coupon payments erode with inflation, maღking them less valuable.

Moreover, the amount initially invested in a long-term bond, known as the principal, will have less purchasing power when it is returned several years from now than it is today. As a result, i✱nflation plays an important role in understanding the relationship between stock and bond prices.

A second reason has to do with relative riskiness. Bonds are often seen as less volatile and more conservative, in general, than stocks. If investors feel that stocks are overbought or the economy is shaky and a selloff is likely, they may shift funds out of riskier assets like stocks and invest that money in bonds. This is known as “澳洲幸运5开奖号码历史查询:flight to safety,” where selling pressure in stocks accelerates downward🅺 prices while bonds get bid up.

Researchers looking at the price relationship between stocks and bonds, however, suggest the assumed negative correlation is no🎶t so straightforward and could be merely an illusion.

Empirical research looking at the historical movement of the two asset classes shows that there are periods of negative correlation, but mostly, they are positively correlated. Research looking as far back as 1926, in fact, shows that the stock/bond correlation has been positive for the vast majority of the time, with just three significant periods of negative correlation: 1929 to 1932, 1956 to 1965, and 1998 to 2003.

Negative Correlations and Forex Trading

The foreign exchange, or forex market, involves trading currencies that are priced in pairs. As such, no single pair trades completely independently of the others. Once you are aware of the correlations among and between different currenc🌳ies and how they change, you can use them to your advantage.

The reason for the interdependence of 澳洲幸运5开奖号码历史查询:currency pairs has a lot to do with the nature of international trade and global financial flows. Countries with large trade deficits have currencies that tend to be🧸 negativelไy correlated with countries showing a surplus. Likewise, the currencies of commodity-rich exporters will often be negatively correlated with countries that rely heavily on imports.

Negative Correlations and Business Management

In business, negative correlations can be identified by management as a way to naturally offset the risks of doing business. These are known as 澳洲幸运5开奖号码历史查询:natural hedges. Executives may 🌞also look at existing relationships, such as between marketing expenditures and sales,ಌ as part of market analysis.

For example, if an expensive marketing campaign is met with declining sales, it could signal that the marketing is backfiring or alienating customers, and should be reconsidered. However, correlations should not be too quickly interpreted as evidence of one variable causing a change in another variabl🌸e. Business environments often present highly complex causes and correlations that may or may not be meaningful.

The Bottom Line

Negative correlations describe a relationship between factors that move in opposite directions. While negative correlations occur in several contexts, they are particularly of interest in the financial world since negatively correlated assets are fundamental to portfolio diversification a꧅nd risk reduction strategies.

𝓰 Even though inverse relationships may persist, correlation does not necessarily mean causation. Furthermore, correlations tend to shift and change in both strength and direction over time.