How negative correlation is calculated
Correlation characterizes the relationship between two quantities, including its presence or absence. The closer this indicator is to unity, the more evenly the analyzed data behave. Negative correlation is recorded when its coefficient is placed between 0 and -1. In this case, one value increases while the other, on the contrary, decreases.
Negative correlation is used in trading to form a balanced portfolio and manage risks. To calculate it, an algorithm consisting of several stages is used.
The first thing to start with is choosing two groups of data that have a similar number of elements, transferring them to Excel, and using the Correlation function, the coefficient is calculated. When you need to compare a large array of data, it is better to use the Analysis Package function.
The closer the result is to -1, the stronger the negative correlation is. Ideally, at -1, the increase of one datum leads to a decrease of the other datum by the same amount.
In the stock market, the negative correlation is rare as opposed to the positive one. For example, a rise in oil prices contributes to a rise in the stock price of Russian companies because the local economy is closely tied to the situation in the oil and gas sector. The same pattern is observed in the U.S. market, where the easing of monetary policy rules and a rise in economic indicators led to an increase in the value of securities.
As for the negative correlation, its example is the quotations of cryptocurrency and NASDAQ index in May of this year. At the beginning of the month, the correlation coefficient here was 0.6, which indicates a positive mutual dynamic. After a while, a number of countries, including the U.S. and China, began talking about imposing restrictions on digital money, due to the negative impact of mining on the environment. This led to a 36% drop in bitcoin and a 33% drop in Ethereum, while stocks continued to show growth. As a result, the correlation between cryptocurrencies and the NASDAQ index changed to -0.6 and it reached -0.15 by the end of the month.
Negative correlation is used by traders to minimize risks, in case one asset declines, the growth of the other can compensate for losses.
Watching the price decrease of one instrument, it is possible to predict the increase of the other one. If you open many positions, it is necessary that some of them have average or strong negative correlation. Thus, it is possible to avoid big losses in case of market abrupts.
However, you should understand that the correlation of values may change rather quickly, so you should reconsider the analysis on a regular basis.
