What is a Negative Correlation?
Negative Correlation Definition
A negative correlation, is a relationship between any two variables in which one increases while another decreases.
For example, albeit a very simplified one, a negative correlation exists between hot coffee and warmer weather.
Negative Correlation Explained
The degree to which two variables are negatively correlated with one another is called a correlation coefficient (denoted by r), and its measurement ranges from -0.1 and -1.
If a relationship were to have a correlation coefficient score of -1, then the two variables would have a perfect negative relationship.
While a score -0.1 would indicate a weak negative relationship between variables.
By squaring a relationship’s R-value, referred to as R-squared, an analyst can then determine the degree to which the variance of the two variables is related to one another.
Expressed in percent, if a R-value was equal to -.6, then the value’s R-squared would equal 36%.
Meaning that the variance in one variable could be explained by the second variable 36% of the time.
Profiting from Negative Correlations
In finance, negative correlations come in handy when attempting to diversify a portfolio.