The crash correlation indicator will tell you if a specific instrument is a good source of diversification of your portfolio.
As you know, correlation can be a tricky thing. Under normal conditions a stock might only be loosely correlated to its index, but when there is a strong market movement, correlation will change to nearly 100%. This indicator visualizes this behavior and lets you search for stocks, which behave independently, regardless what the index is doing.
Minimum Crash Setting
The crash correlation indicator has got one main setting – the minimum movement. If you set it to zero, the indicator will show you the “normal” correlation of the stock to the index, measured in %. The interesting part starts when you set this input to a number bigger than 0. Then the correlation is only calculated on the days, when the index moves at least the given amount.
Have a look at the screenshot: The upper indicator shows the correlation between Verizon and the Dow Jones index. It fluctuates around 50 to 60%. The lower indicator shows the correlation on days, when the Dow Jones moves at least 1% up or down. And as you can see the correlation on these days is way higher. It fluctuates around 80-90%. According to this study Verizon is not a good hedge for Dow Jones moves.
Diversification for your Portfolio
Using this indicator, you can decide if a specific instrument is a valid source of diversification in your portfolio. If you have a closer look at the screenshot below, you will see what I mean.
The first crash correlation row gives you the everyday correlation. The second row gives you the correlation of the specific equity vs. the Dow Jones index if the index moves more than 1% in either direction. As you can see all stocks are highly correlated when the index starts to move. Only the commodities group correlation does not change with large index movements. The correlation to the Dow Jones is about the same on normal days as it is on crash days. It stays around 50%. That`s why there is no way to around putting commodities in every absolute return portfolio.
Crash Correlation Indicator Code
Tradesignal® is a registered trademark of Tradesignal GmbH. Unauthorized use or misuse is strictly prohibited. Data by Teletrader.