Correlation Trading — Trading Wiki

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Published by TradeHQ. Site creator: Anuga Weerasinghe. This page has no recorded editorial review date; the About page explains the site's editorial approach.

What Correlation Trading means

Studying sampled relationships between asset returns. Correlations vary with the interval and period; a divergence need not reverse or create a profitable trade.

In depth

Correlation summarizes a linear relationship in a chosen sample; it does not establish causation or a permanent link between assets. For market comparisons, state the return interval, matching dates and data treatment. Correlation can change across windows and can be undefined when a series has no variation. A pairs-trading example hypothesizes a relationship between positions, often long and short, but a widening spread need not revert. Costs, borrowing, hedge mismatch and market exposure can produce losses. Any numeric example must be labelled hypothetical unless its dataset is supplied.

TradeHQ cannot open the short leg of a pairs trade.

Key points

• Measures how assets move relative to each other (-1 to +1 scale)
• Pairs trading assumes a relationship that can change; divergence can continue and cause losses
• Correlations can change during stress; neither universal convergence nor equal losses is implied

Why it matters when you are learning

Calculate correlations with matching dates, return intervals and data sources. Relationships can change; a correlation estimate alone does not determine an appropriate portfolio.

Worked exercise and its limits

Compare matching daily percentage returns, not raw price levels, over an explicit sample. Recalculate over a second window. A changed estimate or a widening spread need not reverse; a long-short example requires paper calculations because TradeHQ cannot short.