Correlation Analysis

In this introductory article, we will be covering correlational analysis as it is used in binary options trading. For those of you who are relatively new to the investing industry, it should be known that there are several different styles of trading analysis that can be applied when investing online with binary options:

  1. Fundamental analysis
  2. Technical analysis
  3. Correlational analysis
  4. Trader choice and market sentiment

Out of the three forms of trading analysis, correlation analysis is perhaps the most overlooked and under utilized form of trading analysis, yet it is the most simple out of the three. The unique characteristic of correlation analysis is that it can be categorized in tangent with both fundamental analysis and technical analysis. Correlation analysis requires investors to focus on the association between the price of two different assets and how they behave in correlation to one another. Unlike technical analysis, where you have to focus on setting up a charting solution, implementing technical trading indicators and applying a trading strategy, you can make accurate predictions by incorporating correlation analysis into your trading arsenal by making accurate predictions off of other forms of trading analysis.

Correlation analysis: two types of correlations

There are two types of correlation that can directly or indirectly affect the value of an investable asset: a positive correlation and a negative correlation. If two assets share in association with one another a positive correlation, then the two assets oftentimes move in tangent and sync with one another. However, if two different assets share a negative correlation with one another, they oftentimes indirectly affect the value of the correlating asset, causing the asset to move in the opposite direction of its’ correlated pair.

Example

A common example that we enjoy using when trying to explain how correlation analysis can be used in combination with technical analysis would be that you are a binary options investor who relies heavily on the use of charting solutions, technical trading indicators and profitable trading strategies to execute your binary option investments. In lenient terms, you are relying mostly of the implementation of technical analysis opposed to fundamental analysis in order to make more accurate predictions concerning the future direction of your targeted asset. Now let’s say you are a gold enthusiast and you love investing the Gold commodity with binary options, which in all honesty is one of the most popular assets invested in binary options. By applying correlation analysis you know that Gold and the S&P 500 share a positive correlation with one another, so when the value of Gold rises or falls, you can insinuate that the value of the S&P 500 will follow in sync with the Goldcommodity, allowing you to place two investments instead of one.

Another example that we commonly use when providing our subscribers with an example of correlational analysis in combination with fundamental analysis would be that you are a binary options investor who loves to rely on the use of fundamental analysis because charting solutions are just too much of a hassle. You notice that there is going to be a press release later concerning the rate of oil which can severely affect the value of many currency pairs. By applying correlation analysis you know that the EUR/USD currency pair and Crude Oil share a strong negative correlation with one another so if the value of Crude Oil rises then the value of the EUR/USD currency pair should decrease and vice versa. So if you believe that the value of Crude Oil is going to rise, like it most oftentimes does, you can insinuate that the value of the EUR/USD currency pair will decrease thus opposed to only placing one investment, now you can place two high probability investments, providing you with the potential of making a larger profit.

Conclusion

One imperative truth to keep in mind when applying correlation analysis is that correlation does not also mean causation. Just because two assets share a positive or negative correlation with one another does not always mean that they will be directly or indirectly affected the way they historically tend to be. If you have any questions, suggestions or comments regarding this brief introduction in Correlation Analysis please feel free to leave your input below or contact us directly!

Listen to Michael Freeman explaining correlation analysis:

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