Negative Correlation

A variable rises, another falls

What is a negative correlation?

Negative correlationship is a relationship betweeon two variables that move in opposite directions. In other words, when variable A increases, variable B decreases. Negative correlation is also known as inverse correlation.

Two variables can have varying strengths of negative correlation. A variable A could be strongly negatively correlated with B, and may have a correlation coefficient of -0.9. This means that for every change in unit of variable B, variable A experiences a decrease by 0.9. As another example, these variables could also have a weak negative correlation. A coefficient of -0.2 means that for every unit change in variable B, variable A experiences a decrease, but only slightly by 0.2.

In Financial Instruments

The concept of negative correlation is important for investors or analysts who are considering adding new instruments to their portfolio. When market uncertainty is high, a common consideration is rebalancing portfolios by replacing some instruments that have position correlation with those that have negative correlation.

The portfolio movement offsets each other, reducing risk but also return. After market uncertainties diminish, investors can start closing offset positions. An example of a negative correlation instrument is a short-sell stock position, which gains as a stocks price falls.

Negative Coefficient

A pair of instruments will always have a coefficient that lies between -1 to 1. A coefficient below zero indicates a negative correlation. When two instruments have a correlation of -1, these instruments have a perfectly inverse relationship. If instrument A moves up by $1, instrument B will move down by $1. In another example, if the correlation between the EUR/USD exchange rate and USD/CHF exchange rate has a coefficient of -0.85, for every 100 points the EUR/USD moves up, the USD/CHF will move down by 85.