Sid Hopps
Apr 20, 2023
Simple linear correlation is a measure of the degree to which two variables vary together, or a measure of the intensity of the association between two variables.
Simple linear correlation is a measure of the degree to which two variables vary together, or a measure of the intensity of the association between two variables.
The value of r lies between −1 and 1, inclusive.
The sign of r indicates the direction of the linear relationship between x and y:
If r<0r<0 then y tends to decrease as x is increased.
If r>0r>0 then y tends to increase as x is increased.
The size of |r| indicates the strength of the linear relationship between x and y:
If |r| is near 1 (that is, if r is near either 1 or −1) then the linear relationship between x and y is strong.
If |r| is near 0 (that is, if r is near 0 and of either sign) then the linear relationship between x and y is weak.
Key Takeaways:
The linear correlation coefficient measures the strength and direction of the linear relationship between two variables x and y.
The sign of the linear correlation coefficient indicates the direction of the linear relationship between x and y.
When r is near 1 or −1 the linear relationship is strong; when it is near 0 the linear relationship is weak.
We attempt to capture trends with high positive R values (long only trades) and ride the trends until the correlation coefficient begins to deteriorate.