what is negative correlation 
negative correlation is a relationship between two variables in which one variable increases as the other decreases and vice versa in statistics a perfect negative correlation is represented by the value 1 0 while a 0 indicates no correlation and 1 0 indicates a perfect positive correlation a perfect negative correlation means the relationship that exists between two variables is exactly opposite all of the time investopedia ellen lindnerunderstanding negative correlationnegative correlation or inverse correlation indicates that two individual variables have a statistical relationship such that their prices generally move in opposite directions from one another if for instance variables x and y have a negative correlation or are negatively correlated as x increases in value y will decrease similarly if x decreases in value y will increase though this article discusses negative correlation regarding investments negative correlation plays a factor in many facets of business and finance for example negative correlation also has a loose function when considering the learning curve as more time is spent learning something it often takes less time to perform a given task in this example rework or failure decreases as proficiency due to learning increases the degree of correlation between two variables is not static but can swing over a wide range or from positive to negative and vice versa over time negative correlation and the correlation coefficientthe degree to which one variable moves in relation to the other is measured by the correlation coefficient which quantifies the strength of the correlation between two variables for example if variables x and y have a correlation coefficient of 0 1 they have a weak negative correlation but if they have a correlation coefficient of 0 9 they would be regarded as having a strong negative correlation the higher the negative correlation between two variables the closer the correlation coefficient will be to the value 1 by the same token two variables with a perfect positive correlation would have a correlation coefficient of 1 while a correlation coefficient of zero implies that the two variables are uncorrelated and move independently of each other the correlation coefficient usually denoted by r or r can be determined by regression analysis the square of the correlation coefficient generally denoted by r2 or r squared represents the degree or extent to which the variance of one variable is related to the variance of the second variable and is typically expressed in percentage terms for example if a portfolio and its benchmark have a correlation of 0 9 the r squared value would be 0 81 the interpretation of this figure is that 81 of the variation in the portfolio the dependent variable in this case is related to or can be explained by the variation of the benchmark the independent variable negative correlation and portfolio diversificationthe concept of negative correlation is a key one in portfolio construction negative correlation between sectors or geographies enables the creation of diversified portfolios that can better withstand market volatility and smooth out portfolio returns over the long term the building of large and complex portfolios where the correlations are carefully balanced to provide more predictable volatility is generally referred to as the discipline of strategic asset allocation consider the generally historic long term negative correlation between stocks and bonds stocks generally outperform bonds during periods of strong economic performance but as the economy slows down and the central bank reduces interest rates to stimulate the economy bonds may outperform stocks in this example investors often have a strong asset class regardless of how the economy is performing the ultimate goal of diversification is to find assets that are negative correlated this may extend beyond just the asset class as gold etfs may act differently and have different risks than physical gold bars all else being equal a highly diversified portfolio means an investor is holding negatively correlated assets equities and bonds generally have a negative correlation but like other asset classes correlation fluctuates and these two assets become more and less correlated during certain circumstances advantages and disadvantages of negative correlationas mentioned above a negative correlation is useful when attempting to diversify across assets holding assets that move in different directions often reduces portfolio risk of loss in addition to a lower risk of loss investors may experience a lower risk of general volatility different industries may offset each other in the long run by holding both electric car companies and traditional car companies changes to one industry may be offset by opposing changes over time investors may find that pursuing negative correlation is a more engaging way to invest consider only investing in one asset class such as airlines instead by expanding into equities for healthcare providers streaming services or financial services investors may find the research of these new industries more enjoyable considering companies businesses may decide to expand into differentiating goods with a negative correlation to maximize revenue instead of cannibalizing one product line with another two negatively correlated product lines may never compete this may also allow the company to deploy different resources instead of having to rely on a single failure point though a negative correlation may be insightful it may also be misleading if the associated assets are not actually negatively correlated consider the negative correlation between ski lift tickets and shark attacks one may make misleading decisions based on negative correlations in addition be mindful that the correlation of two items today may be widely different tomorrow due to a change of circumstance for portfolio management a negative correlation also indicates that very different assets are being held this may mean an investor is not an expert on an asset they are holding and may be unaware of asset risks for example though farmland may have a negative correlation to equities investors may not have tremendous experience in the agriculture industry last negative correlation in a portfolio means different asset classes are being held to reduce risk in exchange for lower risk investors are willing to sacrifice potentially higher returns by not diversifying for example buying bonds may result in negative correlation but also in lower returns may reduce a portfolio s short term risk of lossmay reduce a portfolio s long term risk of volatilitymay be a more enjoyable strategy to investing for retail investorsmay allow a company to have multiple non competing product linesmay be misleading if data suggests correlation means causationmay expose an investor to asset classes they do not have adequate knowledge ofoften results in lower potential portfolio returns in exchange for greater risk protectionmacroeconomics and negative correlationit should be noted that this investment thesis may not work all of the time as the typical negative correlation between oil prices and airline stocks might occasionally turn positive for example during an economic boom oil prices and airline stocks may both rise conversely during a recession oil prices and airline stocks could slide in tandem 