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A correlation coefficient is a numerical, descriptive measure of the strength of the linear relationship between two variables. Values for the correlation coefficient range between -1 and +1, with a correlation coefficient of +1 indicating that the two variables have a perfect, upward-sloping (+) linear relationship and a correlation coefficient of -1 showing that the two variables are perfectly related in a downward-sloping, (-) linear sense. A correlation coefficient of 0 demonstrates that the variables have no relationship, and are independent. A correlation coefficient is determined through statistical analysis of sample data as it is fitted to a modeled linear equation. For investors, knowing a correlation coefficient can be useful in the following way: If one finds that the S&P 500 (variable x) has a 0.85 correlation coefficient with regards to their investment fund's average returns (variable y), the the investor can expect a pretty strong positive relationship between gains in the S&P and his/her portfolio. If the correlation coefficient were -0.85, the investor could expect to see his/her portfolio lose value as the S&P gains. |
