A:

The correlation between any two variables (or sets of variables) summarizes a relationship, whether or not there is any real-world connection between the two variables. The correlation coefficient will always be between -1 and +1. These two extremes are considered perfect correlations. A negative coefficient means that the two variables, or sets of variables, will move in opposite directions (if one variable increases, the other will decrease); a positive coefficient will mean that the two will move in the same direction (as one increases, the other will increase).

If we compare the US Dollar Index (USDX), an index that tracks the value of the U.S. dollar against six other major currencies, and the value of the Dow Jones Industrial Average (DJIA), Nasdaq and S&P 500 over a 20-year period, the correlation coefficient calculated for the USDX versus the DJIA, Nasdaq and S&P 500, is 0.35, 0.39 and 0.38, respectively. Note that all of the coefficients are positive, which means that as the value of the U.S. dollar increases, so do the stock indexes, but only by a certain amount. Notice also that each coefficient is below 0.4, which means that only about 35% to 40% of the stock indexes' movements are associated with the movement of the U.S. dollar.

A country's currency can become more valuable in relation to the rest of the world in two main ways: when the amount of currency units available in the world market place is reduced (for example, when the Fed increases interest rates and causes a reduction in spending), or by an increase in the demand for that particular currency. The fact that an increase in the U.S. dollar affects the value of American stocks seems natural, as U.S. dollars are needed to purchase stocks.

The value of American stocks, especially those that are included in market indexes, tend to increase along with the demand for U.S. dollars - in other words, they are positively correlated. One possible explanation for this relationship is foreign investment. As more and more investors put their money in U.S. equities, they are required to first buy U.S. dollars, which can be used to purchase American stocks, causing the indexes to increase in value.

For more insight, see Commodity Prices And Currency Movements and Using Currency Correlations To Your Advantage.

RELATED FAQS
  1. How do I calculate correlation between market indicators and specific stocks?

    Discover how to calculate the correlation coefficient between market indicators and stock prices, a critical skill in technical ... Read Answer >>
  2. Can the correlation coefficient be used to measure dependence?

    Understand the coefficient of correlation and its use in determining the relationship between two variables through the concepts ... Read Answer >>
  3. How does correlation affect the stock market?

    Learn about the role correlation plays in prudent stock market investing, and how the correlation coefficient is used to ... Read Answer >>
  4. Does a negative correlation between two stocks mean anything?

    Learn what the concept of negative correlation means, understand how it is generally calculated and see how it is used in ... Read Answer >>
  5. What is the difference between positive correlation and inverse correlation?

    Learn the difference between a positive correlation and a negative, or inverse, correlation and the way they apply to the ... Read Answer >>
  6. What are some examples of positive correlation in economics?

    Learn the most common examples of positive correlation in microeconomics and microeconomics, including demand and price, ... Read Answer >>
Related Articles
  1. Investing

    What's the Correlation Coefficient?

    The correlation coefficient is a measure of how closely two variables move in relation to one another. If one variable goes up by a certain amount, the correlation coefficient indicates which ...
  2. Investing

    Correlation

    In the world of finance, correlation is a statistical measure of how two securities move in relation to each other.
  3. Investing

    Is the Stock Correlation Strategy Effective?

    The synchronized movement among stocks and markets in recent years is challenging diversification.
  4. Financial Advisor

    4 Reasons Why Market Correlation Matters

    Learn about how correlation can be used to measure how broader markets move in relation to each other. See how correlation is used to manage risk.
  5. Trading

    Using Currency Correlations To Your Advantage

    Knowing the relationships between pairs can help control risk exposure and maximize profits.
  6. Insights

    Prices of Stocks and Bonds Move More in Tandem

    Correlation between stock and bond prices in the U.S. have reached a 10-year high, reversing a broader trend of negative correlation.
  7. Investing

    Calculating the Coefficient Of Variation (CV)

    Coefficient of variation measures the dispersion of data points around the mean, a statistical average.
  8. Investing

    Commodities: The Portfolio Hedge

    These diverse asset classes can provide downside protection and upside potential. Find out how to use them.
  9. Investing

    Regression Basics For Business Analysis

    This tool is easy to use and can provide valuable information on financial analysis and forecasting. Find out how.
RELATED TERMS
  1. Pearson Coefficient

    A type of correlation coefficient that represents the relationship ...
  2. Information Coefficient - IC

    A correlation value that measures the relationship between a ...
  3. Coefficient of Determination

    A measure used in statistical model analysis to assess how well ...
  4. Benchmark For Correlation Values

    A benchmark or point of reference chosen by an investment fund ...
  5. Berry Ratio

    The ratio of a company's gross profits to operating expenses. ...
  6. Variable Cost Ratio

    Variable costs expressed as a percentage of sales. The variable ...
Hot Definitions
  1. Audit

    An unbiased examination and evaluation of the financial statements of an organization.
  2. Efficiency Ratio

    Ratios that are typically used to analyze how well a company uses its assets and liabilities internally. Efficiency Ratios ...
  3. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  4. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin account. In the context of the NYSE and FINRA, after an ...
  5. Salvage Value

    The estimated value that an asset will realize upon its sale at the end of its useful life. The value is used in accounting ...
  6. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
Trading Center