What is Positive Correlation
Positive correlation is a relationship between two variables in which both variables move in tandem. A positive correlation exists when one variable decreases as the other variable decreases, or one variable increases while the other increases. In statistics, a perfect positive correlation is represented by 1, while 0 indicates no correlation, and negative 1 indicates a perfect negative correlation.
BREAKING DOWN Positive Correlation
A perfect positive correlation means that 100% of the time, the variables move by the exact same percentage. A positive correlation can be seen between the demand for a product and the product's associated price. In situations where the available supply stays the same, the price will rise if demand increases. Additionally, gains or losses in certain markets may lead to similar movements in associated markets. As the price of fuel rises, the prices of airline tickets also rise. Since airplanes require fuel to operate, an increase in this cost is often passed to the consumer, leading to a positive correlation between fuel prices and airline ticket prices.
A positive correlation does not guarantee growth or benefit. Instead, it is used to denote any two or more variables that move in the same direction together, so when one increases, so does the other. While the correlation exists, causation may not; thus, while certain variables may move together, it may not be known why this movement occurs.
Correlation is a form of dependency, where a shift in one variable means a change is likely in the other, or that certain known variables produce specific results. A general example can be seen within complementary product demand. If the demand for vehicles rises, so will the demand for vehicular-related services, such as tires. An increase in one area has an effect on complementary industries.
Positive Correlation in Finance
A simple example of positive correlation involves the use of an interest-bearing savings account with a set interest rate. The more money that is added to the account, whether through new deposits or earned interest, the more interest that can be accrued. Similarly, a rise in the interest rate will correlate with a rise in interest generated, while a decrease in interest rate causes a decrease in actual interest accrued.
Psychology and Positive Correlation
In certain situations, positive psychological responses can cause positive changes within an area. This can be demonstrated within the financial markets, in cases where general positive news about a company leads to a higher stock price.