Market Correlation Report

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Click the [Market By Correlation] button on the left-hand side of the Daily Market Report to view CSI's exclusive correlation tables. You can also reach this point from within your Unfair Advantage software by choosing "Correlation Report" from the Trading Tools menu.

CSI tracks nearly 1,000 world futures markets daily, which are as diverse as world economies can offer. Information on products like Dried Cocoons from Japan, Pork Bellies from the U.S., Rubber from Malaysia and Rapeseed (Canola) from Canada may seem totally unrelated until you view CSI's revealing correlation study. This convenient study can now paint a picture of market correlations that may suggest enormous opportunities for future arbitrage profits. It clearly identifies market pairs that are highly positively correlated and that are highly negatively correlated.

This study also produces correlation reports for major stocks, and for combination of stocks and commodities.

Methodology

This study pairs off, in a daily frequency, every world futures market with every other world futures market over the past 12, 20, 30 or 40 years (where possible), ending with the day of trading last observed.

Click on the link for the time period and market category or categories you wish to view.

The example shown here is for Futures only, but as you can see from the above selection table, you may view correlation reports for Futures Only, Major Stocks Only or a combination of Futures and Major Stocks. Scroll down to view each of the correlation tables.

Positives and Negatives
Correlation coefficients are statistical measures of how each member in a pair of markets relates to the other. There are two parts to the correlation coefficient -- the sign and the magnitude. The magnitude, also known as the absolute value, ranges from zero to one and indicates the strength of the relationship. The sign (positive or negative) indicates the direction of the relationship. A value of 1.0 is perfect positive correlation – the two members of the pair move up and down together in unison. If two markets move in exactly opposite directions, then they have a perfect negative correlation, with a correlation coefficient of -1.

Here is a general guide for determining the strength of a correlation:
0.00 – 0.20: slight; almost negligible relationship
0.20 – 0.40: low correlation; definite but small relationship
0.40 – 0.70: moderate correlation; substantial relationship
0.70 – 0.90: high correlation; marked relationship
0.90 – 1.00: very high correlation; very dependable relationship

A Look at the Numbers

The correlation tables may show some inconsequential data, such as a perfect correlation between contracts that are essentially the same, e.g. Day-Session T-Bonds and Globex T-Bonds. However, if you look a little farther down the sample list, you'll find weightier data. For example, say there is a high correlation coefficient (.998) for the pair consisting of NYMEX Light Crude Oil (CL) and IPE Brent Crude Oil (LCO). No big surprise there, but it is important to know that energy prices are in step on both sides of the Atlantic. Other highly correlated pairs might include the German Bund with a number of other countries' government securities. Several stock indexes show high correlations with each other, as do various grain contracts.

Among the least correlated pairs are a few grains with several stock indexes, such as the NYSE Composite Index with Barley (-.934), and gold with stock indexes. A host of currencies round out the list of negatively correlated markets, reflecting the inverse nature of foreign exchange.

The correlation tables showing the most positively and negatively correlated markets are likely to reveal several glaring opportunities for profit using spread trades, but tables also illuminate inevitable random market distortions that will eventually return to correlated norms. The markets' return to the norm is what will help you earn a substantial profit.

It is up to the trader to determine, based on sound economic analysis, if a given number is a "false positive" signal.

Click on any pair of markets in the correlation tables to view one-year price charts of the individual Perpetual Contract series and a three-line chart showing sigma values.

The example above shows a pair of markets as they have jointly declined from their average price over the past year. The difference between these two markets is shown in a third graph on the same chart image. Please notice that when market A is above market B, the difference line (C) lies above zero. The opposite is true when B is stronger than A. The trader should watch the difference levels over the period of study, gage the relationship's credibility and decide when and whether to initiate a given trade.

Trading Strategies
(Not to be construed as investment advice. All futures trading involves substantial risk of financial loss.)

How can you use this information to make better trading decisions? First, decide upon your trading strategy. Unless you are trading very specific spreads or arbitrages, you will probably want to be as diversified as possible. The correlation coefficient table sheds light on true diversity of investments. For example, if you take long positions in many markets in an effort to diversify, but all those markets are highly correlated, (negatively or positively) then you lose the diversification you sought. Trading multiple positively correlated markets or multiple negatively correlated markets is equivalent to pyramiding and serves to amplify your risk. Diversification is best achieved by trading markets with correlation coefficients that are low-magnitude (closer to zero).

In a positively correlated pair where two markets over the past twelve years have demonstrated a correlation of over 0.90, the trader should be prepared to sell the stronger market and buy the weaker market. A similar profit opportunity is presented when a pair of markets shows a historical tendency to be negatively correlated. In this scenario, opportunities for profit arise when the difference line shows the pair of markets to be moving together. The trader's focus should be to capitalize upon their tendency to move apart.

Before embarking upon a paired investment where one market is sold and the other is simultaneously bought (such as might be suggested with the stock index and barley on the correlation table), be certain that a real relationship exists that can be depended upon. With thousands of possibilities visited, some will emerge as accidental associations that will not prove to be fruitful opportunities worthy of investment.

One important aspect to remember about spread and straddle trades is that the dollar value of both legs should be roughly equal. For example, if the value of the commodity you are shorting is $30,000 per contract and the value of the desired long position is $10,000 per contract, you should triple up on the long position to make both legs balance at $30,000 each. Balancing your investments can be more complicated than this, (based on volatility, for example) but it is a worthwhile exercise that can usually be accommodated by either adding contracts or selecting compatible contract sizes from various exchanges.

Unfair Advantage allows you to view the full contract value of your commodities through a feature on the charting "Right Click" menu. Create a chart of both markets through UA (as opposed to the website) to view.