Glossary

Technical Foundations

Positive Correlation

Correlation describes the relationship between two variables. Variables that are positively correlated tend to move in the same direction. A stock that moves up when the stock market rises is said to be positively correlated, although the magnitude of the rise of the stock relative to the market will depend on a number of factors. For a more technical definition, Abdulla Javeri, in his video series on Finance Unlocked, says correlation scales or standardises the covariance number. It is calculated by dividing the covariance by the product of the respective standard deviations of the two assets being considered. The result is a correlation number between minus one and plus one. The sign defines the directional relationship and gives an idea of the strength of that relationship. A number close to zero suggests that the movements of the two assets are unrelated i.e. uncorrelated. The closer one moves to the limits of minus and plus one, the greater the connection. If it’s plus one, movements in one are exactly mirrored by movements in the other. Squaring the correlation number tells us what proportion of the change in one can be explained by a change in the other.