1. What is Correlation?

Positive Correlation

A positive correlation—when the correlation coefficient is greater than 0—signifies that both variables move in the same direction. When ρ is +1, it signifies that the two variables being compared have a perfect positive relationship; when one variable moves higher or lower, the other variable moves in the same direction with the same magnitude.

The closer the value of ρ is to +1, the stronger the linear relationship. For example, suppose the value of oil prices is directly related to the prices of airplane tickets, with a correlation coefficient of +0.95. The relationship between oil prices and airfares has a very strong positive correlation since the value is close to +1. So, if the price of oil decreases, airfares also decrease, and if the price of oil increases, so do the prices of airplane tickets.

In the chart below, we compare one of the largest U.S. banks, JPMorgan Chase & Co. (JPM), with the Financial Select SPDR Exchange Traded Fund (ETF) (XLF).12 As you can imagine, JPMorgan Chase & Co. should have a positive correlation to the banking industry as a whole. We can see the correlation coefficient is currently at 0.98, which is signaling a strong positive correlation. A reading above 0.50 typically signals a positive correlation.

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