If the DARWINs which we choose for our portfolio are highly correlated, when we invest in them, not only are we not diversifying, but in effect it would be the same as investing all our capital in just one DARWIN.
What is it?
The correlation measures the degree to which two DARWINs' returns move in relation to each other. Do they move in a similar way, or are they completely different?
This information is very important when it comes to creating a portfolio of DARWIN because, if the DARWINs are highly correlated, when we invest in them, not only are we not diversifying, but in effect it would be the same as investing all our capital in just one DARWIN.
The results of a correlation coefficient are measured between +1 and -1.
- A value of 0 implies a complete decorrelation. Their returns move independently from one another.
- A value of 1 implies the maximum correlation, or perfect positve correlation, in other words, there is a degree of dependency between the two DARWINs. When one of their quote prices rises, the other will also rise by the same proportion.
- A value of -1 implies the maximum inverse correlation of a perfect negative correlation. This means that when one of the DARWINs increases its quote price, the other will decrease by the same proportion.
- Values beyond +0.5 or -0.5 are considered highly correlated.
Where can this be checked?
All DARWINs have a ''Correlation'' tab made up of a correlation chart, as well as a graph where the return curve's movements for both DARWINs is shown.
This shows us the 10 most highly correlated DARWINs compared with the chosen DARWIN. By clicking on the arrows just above the chosen DARWIN, you can see the next 10 most highly correlated DARWINs, and so forth.
Return Curve's movement graph
You can use this to compare the returns between two DARWINs. In addition you can use the search bar to change the DARWIN which you want to comprar by simply entering the ticker.
Furthermore, in the ''Porfolio Risk'' section, in the DARWIN Terminal, you will have access to a matrix showing the correlation between all the DARWIN which you have currently invested in.
High and low correlation
Let's look at two cases of high and low correlation so as to ensurethat we have fully understood the concept.
At a quick glance, you can see that these DARWINs' returns have moved symmetrically, therefore their correlation is 0.93.
On the other hand, these two DARWINs, whose returns have moved dependently from each other, show a correlation of -0.07.
1. Diversify correctly
At Darwinex we recommend investing in a diversified porfolio of DARWINs so as to minimise the portfolio's risk. In order to do so correctly, check that the DARWINs you choose do not show a high correlation, whether that be positive or negative.
2. Between -0.5 and +0.5
Those DARWINs which have values between -0.5 and +0.5 are considered to be decorrelated. Beyond these values correlation starts to become a factor to take into account when choosing DARWINs.
3. Correlation evolves
The fact that two DARWIN have been highly correlated for a time does not mean to say that this will be the same throughout the future, because correlation evolves with time. The opposite is also true, therefore you have to periodically check your porfolio of DARWINs and ensure that there are no high levels of correlation between them.
Do you want to learn more?
We use the standard correlation formula, but with the following features:
- We measure the return in 8 hour blocks.
- We take the last 63 block in which at least one of the two DARWINs has been trading.
- Therefore the Darwinex correlation coefficient takes into account approximately the last 21 days, in other words, a month in trading days in the which both DARWINs have been trading.