Correlation

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damian
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Correlation

Post by damian »

Will you be grouping SB in with CL, NG, HO and HU?
Old European
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Post by Old European »

... because of recent strong demand for cane-based ethanol in top cane-grower Brazil because of high energy prices you mean? Short term correlation has indeed increased, but long term correlation has changed only marginally.

Cheers,

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damian
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Post by damian »

Hello OE,

Yes, thats it. It was an unexpected dynamic, at least for me.

Long term vs short term correlation... a slippery surface indeed. A very short term break down in long term correlation can cause significant account losses. And basing long term trade decisions on short term swings in correlation can deny you good, low volatility profits. Correlation sits very comfortably in the 20/20 hindsight category. I tend to be biased towards shorter term correlation, particularly when you are fully loaded in instruments that are quickly becoming correlated for logical economic reasons.
Chris67
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Post by Chris67 »

I agree with Damian - I have spent years analysing the correlation topic and heres my hypothesis -

Everything is correlated until it isnt anymore and nothing is correlated until suddenly it is

Dont mean to be flip but I actually believe this and think theres no way to backtest correlation problems - For years the Dollar used to go up and down with s and p's but then 2000 - 2004 the dollar tanked about 40 % and U.S stocks went the same way - This is a major problem of backtesting and Systematic trading - I think you need to observe markets and use your own common sense about whats currently in Vogue regarding what the markets thinks the effect of x will be on y - presently the market thinks stox are a negative on high oil prices and they cannot make up their minds on Bonds -
The whole question is answered by watching those idiots on CNBC - if oil has an upday and so do stox then its because oil stocks are higher - If however oil goes up and stocks go down its because high oil prices are bad for stocks - Just another example of why CNBC and fundamental analysis is all aload of rubbish

Chris
damian
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Post by damian »

Hi Chris - I hope business is running well for you.

There probably are empirically based mechanical solutions to the issue, but I can get a handle on them.

I think though, as much as you rubbish fundamentals (and I agree to a large extent), it is a fundamental perception that is required when applying your own commonsense to changes in market relationships. Sugar isn't the only agricultural market that may become correlated with energy prices. There are a few grains which, for sound fundamental principles, could also join the party.

I think the best mechanical approach to managing correlation risk (and the changes thereof) is to assume that everything is potentially correlated at any time. You used an exact turn of phrase that I quite like:
Everything is correlated until it isn't anymore and nothing is correlated until suddenly it is
Eventually I ask myself of how much use is it to be fundamentally clued in. After all, there needn't even be a sound fundamental reason for changes in correlation and these seemingly coincidental changes can create large account losses in the very short term just the same as 'justified correlation changes.

For me, the answer would be to let correlation do what ever it is going to do whilst I keep my account portfolio heat very low. At least, that would be my answer if I had a few million with which to trade. Correlation is the exact reason why long term portfolio trend following requires a large account.
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