A little while ago I did a basic correlation study. It looked at the markets as well as at the Trade Leaders over the June 2010 to September 2011 time frame. In this post I’ll share with you the results.
Let me first start with the correlations between some of the major market asset classes. They include stocks, fixed income, and gold, which together represent the biggest fraction of the asset allocation for most investors these days. Here’s what those cross-market correlations were over that full period.
TLT is the leading long-term Treasury securities ETF and HQD is an EFT that focuses on high grade corporate bonds. GLD is the gold tracking ETF. I opted to use these EFTs to avoid any kind of issues that using cash bonds or futures might have caused in determining period-over-period returns. These correlations are based on weekly figures.
There probably won’t be much surprise in the numbers. Stocks and the bond ETFs are negatively correlated, indicating that stocks and interest rates were generally moving in the same direction. Stocks and the dollar were also negatively correlated, but not hugely so (+1 means totally positively correlated, -1 means totally negatively correlated). The negative correlation between the dollar and GLD is also no surprise.
These aggregate figures mask the reality of the markets, though. Correlations are not static things as the following chart shows.
Here we have the rolling 3-month correlation of the fixed income ETFs, gold, and the USD Index against the S&P 500. Notice how they have moved up and down and all around. For example, the USD Index was mostly negatively correlated to stocks, but for a while there it went to positive. Likewise, gold was mostly positively correlated to stocks, but in the latter part of the covered time it went negative.
Looking at the Trade Leaders
Now let me turn the attention to the Trade Leaders. Here are the figures for how they correlated against the five markets shown in the studies above.
|USD Index||S&P 500||GLD||TLT||HQD|
Notice how small these figures are. The Trade Leaders were modestly negatively correlated to the dollar, but otherwise their returns were essentially not correlated against the other markets. Again, we’re talking about a comparison of weekly returns here. I used an equal weight average return for the Trade Leader which incorporated all those who were active during a given week.
To see what this looks like, here’s a chart which shows a week-by-week comparison of the Trade Leaders and the S&P 500.
The S&P 500 weekly returns are indicated by the bars while the line represents the Trade Leaders. It’s pretty easy to see how unrelated the returns of the two are in this graph. The directions of the plots are frequently different and the amplitudes are almost never the same. That’s basically the definition of uncorrelated.
Diversification of Approach
What we’re seeing with the Trade Leaders correlations is the impact of diversification of trading approach. The index and ETF returns work on the basis of buy-and-hold while the Trade Leaders are employing much more active strategies. Those strategies are somewhat correlated to the direction of the dollar, which will be no real surprise given how much of a focus EUR/USD gets in forex trading, but even that isn’t a close relationship. This tends to indicate that Trade Leader performance is mainly a function of skill, not market performance overall.
Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.