CHAPTER 39
Correlated Risk
Perhaps the toughest challenge to any trader, speculator, or investor is to quantify correlated risk.
Correlated risk is defined by the degree to which individual positions will move in sync to provide either simultaneous profits or losses.
A perfect example would be if I were long gold futures contracts, and long several gold mining companies, and long call options on silver.
I might be tempted to take the viewpoint of having three separate positions. Basing my risk analysis on this thought process could be disastrous if the precious metals complex plummets.
For sure, silver, gold, and gold mining shares move in a positively correlated manner. The most popular way to actually gauge the degree of positive or negative correlation between any two given markets or sectors is to conduct an R-squared regression study.
In my research work, I make great use of correlation studies; the resultant overlay charts compare two markets, providing a unique and most often valuable perspective. However, in my trading and fund management, I have always tended to rely on feel as much as anything.
Nonetheless, I look at a run of correlation figures every day that are reflected in a matrix that provides R-squared calculations in a broad grid of major market sectors. From the perspective of a precious metals trader, it would certainly be important to know if gold’s correlation with the equity market, bond market, and U.S. dollar is trending toward a more, or less, positive ...

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