Additional Information on Stock Correlations

Honestly, I didn’t think much about correlations of stock prices when I first put together the section that showed highly correlated stocks – it was more of an interesting exercise. I had a bunch of stock data and wanted to see what it looked like on the web and showing stocks that were correlated was a straight forward experiment to try. For instance, you can see what stock are correlated with Google, Apple Computers, Yahoo!, Microsoft and IBM (curious side note – sometimes IBM has not correlations over .8) over the past 250 trading days.

Well, Jon gave us some really interesting feedback and brought up some questions about the correlation data we are showing. It seems that Jon is a psychologist specializing in investment and the author of Profits Without Panic : Investment Psychology for Personal Wealth. Let me parse out Jon’s comments and questions:

The fact is that while correlation is an important method there has been very little work in its use as an indicator. Take a look, for example, at a range of websites and platforms and while there are many indicators on offer from moving averages to elliot waves and so on, few if any offer the basic correlation. Surprisingly sites such as Yahoo! give both an r and r-squared value for any stock against a major index so its not like there isn’t a use or a demand.

Jon is correct – it seems that correlation isn’t a big part of the stock trader’s toolbox. Should it be? I am not sure yet. It seems that many people are interested in the correlation of indexes to stocks and look for divergence and such, but looking across all the stocks to get a sense of what stocks are correlated with other stocks – not a top priority for traders.

The point is that a tool that works out correlations is vital to an understanding of market behavior.

Cool – I had not thought about this too much yet. I always seem to be looking for the next problem to be solved before I finish the one I am working with! I definitely need to get some more ideas about this.

Information can be downloaded into Excel as you suggest but it is slow and laborious.

Oh – that was just an article to explain the process for finding correlation and Excel is great for simple demonstrations like that. Indeed, running correlations on 10,000 stocks would be very laborious in Excel (yes – yes – I know – you can write VBA to do it easily…).

Indeed your tool can go further, I believe. What’s needed is the ability to run correlations on stocks and indexes (I found this didn’t actually work on your site by the way) and most importantly to be able to alter the time period.

DeepMarket does not have indexes – sorry! The stock data we have now is pretty expensive as it is – for display on a website. To display indexes is cost prohibitive. You would NOT believe what the exchanges want independent website owners to pay to display index quotes. So, as a matter of practicality, we do not have indexes. Also, the correlations are run once a week. Finding the correlations between 10,000 stocks is a decent computing job and we certainly don’t do any of that on the fly. Altering time frames – adding time frames – is a great idea and we most certainly can do that. What time frames would people like to see?

My feeling is that for long term holding periods a long term correlation may be fine but for short term holding periods a short term correlation is more suited.

Okay – no problem. We can do shorter term correlations. For those, we may run daily computations – depending on the time frames.

I’d be interested to know your thoughts on this and if you have any intentions to expand the functionality of the correlation tool.

Heck yeah! I am interested in any further feedback from all readers. What correlation periods are you interested in? Remember, all I have is daily data.

Thanks for the feedback Jon!