Defined

“Just what is correlation, and how do we derive the correlation coefficient? Correlation is a statistical term giving the strength of linear relationship between two random variables. More simply defined, it is the historical tendency of one thing to move in tandem with another. The correlation coefficient can be a number from -1 to +1, with -1 being the perfectly opposite behavior of two investments (e.g., up 5% every time the other is down 5%), and +1 reflecting identical investment results (up or down the same amount each period). The further away from +1 you get (and thus closer to -1), the better a diversifier one investment is for the other. Correlation coefficient is found by taking the covariance between two variables and dividing by the square root of the product of each of the two variances (trust us on this part). No wonder the eyes of so many glaze over when discussing the topic of correlation. However, it has some very tangible uses, if they can be explained to the novice. The most simplistic description of correlation is the tendency for one investment to “zig” while others are “zagging”.”

John W. Henry Marketing Materials

Correlation Pairs

Example Correlation Matrix (2003)

Example Correlation Matrix (2000)

Example Correlation Matrix (1999)

The following table details correlation coefficients among trend followers. These traders make and lose money at the same time in the same markets. What does that say about their trading styles?

 Trading Pair 07/91-06/95 01/95-01/98 Abraham Trading / Campbell 0.65 0.73 Abraham Trading / Chesapeake 0.71 0.83 Abraham Trading / Eckhardt 0.65 0.74 Abraham Trading / Rabar 0.68 0.77 Abraham Trading / Saxon 0.52 0.74 Rabar / Saxon 0.58 0.66 Rabar / JPD 0.94 0.94 Rabar / Hawksbill 0.75 0.70 Rabar / Eckhardt 0.76 0.76 Rabar / Chesapeake 0.72 0.70 Chesapeake / Eckhardt 0.61 0.74 Chesapeake / Hawksbill 0.62 0.66 Chesapeake / JPD 0.71 0.79 Chesapeake / Campbell 0.65 0.67 Chesapeake / John W. Henry 0.71 0.62 Mark Walsh / Chesapeake 0.54 0.80 Mark Walsh / Eckhardt 0.73 0.80 Mark Walsh / Saxon 0.44 0.74 Mark Walsh / Hawksbill 0.62 0.75 Mark Walsh / MC Futures 0.67 0.66 Eckhardt / Hawksbill 0.75 0.64 Eckhardt / Saxon 0.29 0.71 Saxon / Hawksbill 0.41 0.68 JPD / MC Futures 0.72 0.62 JPD / Eckhardt 0.70 0.79 JPD / Saxon 0.62 0.72 Millburn Ridgefield / Chesapeake 0.61 0.65 Millburn Ridgefield / Campbell 0.75 0.76 Millburn Ridgefield / Dunn Capital 0.76 0.71 Dunn / Chesapeake 0.62 0.62

Correlation coefficients gauge how closely an advisor’s performance resembles another advisor. Values exceeding 0.66 may be viewed as having significant positive performance correlation. And consequently, values exceeding -0.66 may be viewed as having significant negative performance correlation.

Trend Following Products

Review trend following systems and training: