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What does correlation mean?

Financial traders use correlation to describe the movement of securities – how and when they move – relative to each other during a given time period. These relationships lend themselves well to pairs trading, where traders have developed an understanding of correlations and their behavior that allow them to confidently exploit slight changes to minimize risk and maximize profitable transactions. Continue reading...

What does it mean to Accept Risk?

The notion of who bears risk for various sorts of failures, circumstances, or losses is a prevalent one in the financial world, and many institutions make all of their money accepting risks. To accept a risk is to bear the burden of loss or replacement if an event occurs that causes an asset to lose value or disappear. There is a bright side to this, however. There is a real and theoretical “risk premium” due to those who accept a risk. Continue reading...

What is Par Value?

Par value is the nominal value of a security (such as a stock or a bond) that is typically indicated on the certificate of ownership. Par value is most often associated with bonds, and refers to the amount that will be returned to the investor at the bond’s maturity. Par value of bonds is generally $100 or $1,000. Bonds traded on the open market are not generally bought and sold at par value, as they typically trade at a premium or a discount to par. Bond prices are influenced by interest rates, and have an inverse relationship with them. Continue reading...

What is asset allocation?

Asset allocation is theoretically the best way to control the return you experience, through diversification and rebalancing. Asset allocation theories provide you with mechanisms to diversify your money among various asset classes, such as stocks, bonds, real estate, commodities, precious metals, etc. The benefit of asset allocation is twofold: first, nobody knows which asset class will perform better at any given time, and second, various asset classes are not entirely correlated or have a negative correlation, which provides a hedge. If one asset class appreciates significantly, the other might not, but, if the allocation is done correctly, this may be exactly what the investor was looking for. Continue reading...

What is R-Squared?

R-squared is a statistical tool called a correlation coefficient. It is a percentage measurement that represents how closely correlated a security’s movement is with the movements of a benchmark index. Values range between 0 and 1 and are often expressed as percentages between 0% and 100%. A higher R-squared (between 85% and 100%) tells investors that a security moves more or less in correlation with the benchmark index. A lower R-squared (70% or less) means that the security in question moves independently from the index. Continue reading...

Is there such a thing as a “presidential election cycle” impact on stocks?

Some analysts have popularized the notion that the 4-year presidential election cycle holds secrets to bear and bull markets. Found in publications such as the Stock Traders Almanac, The Presidential Election Cycle is the theory that different phases of the presidential term are correlated to broad market conditions. As will many such theories, it may not hold up under a lot of scrutiny, but there are some correlations to be found. Continue reading...

What are Alternative Funds?

The idea with Alternative fund investing is to gain exposure to assets which are not highly correlated with the rest of your portfolio, and which use non-traditional approaches to fund management. Alternative Funds are mutual funds that invest in non-traditional asset classes such as commodities (gold, silver, oil, etc.), agricultural products (cocoa futures, orange futures, pork-belly futures), non-publicly traded companies and limited partnerships, and so on. Continue reading...

What is Unsystematic Risk?

Unsystematic risk is idiosyncratic or unique risk that does not reflect a direct correlation with the risk present in the market, or systematic risk. Most securities and portfolios experience risk and variations which are not attributable to the market as a whole, and this is known as unsystematic risk. Systematic risk, on the other hand, is the risk borne by all investors in the market, where broad changes in the market cannot be avoided through diversification of a portfolio. Continue reading...

What does hypothesis testing mean?

A theory about what will happen and why is a hypothesis, and to prove the hypothesis has some relevancy it will have to be compared to the probability of getting those results by pure chance. A hypothesis is a testable prediction of results that should be observed due to the effects of an independent variable. Such predictions must be tested against the probability of the resulting observations happening due to complete chance instead of the influence of the independent variable. Continue reading...

What is standard deviation?

Standard Deviation is a measurement of how far from the average (mean) the majority of a data set lies. Standard Deviation is a measure of variability, and it is on a different scale for each data set being measured; there is no “standard” standard deviation. It is possible to normalize it for comparison to other data sets using measurements like r-squared and the sharpe ratio. The number arrived at when computing standard deviation is going to reveal the distance, in terms of one of the quantifiable variables being observed, from the average, in either a positive or negative direction, within which 68% of the data set falls. Continue reading...

What is the relationship between major currencies in general?

There are six major currencies traded and used as benchmarks on Forex markets: United States Dollars, Euros, Yen, British Pounds, Australian Dollars, Canadian Dollars, and Swiss Francs. There are also relationships between these and others, known as currency correlations. Currency exchange rates can be fixed or floating, and this is determined by policy within the country and how they want to value their money. Continue reading...

What is beta in investing?

Beta is a volatility indicator that denotes how closely an investment follows movements in the market as a whole; when examining mutual funds, it indicates how similarly the funds move to their relevant indexes. It is often referenced with its counterpart, Alpha; a risk ratio which measures gains or losses relative to a benchmark, indicating whether an investor is being compensated with a return greater than the volatility risk being taken. Continue reading...

How do I determine the right mix of assets?

Asset allocation tools and Monte Carlo simulators are available through broker-dealers and online services. You may wish to construct your own asset allocation, but there are asset allocation programs available which can take a lot of the uncertainty out of the process. The most famous method for analyzing and testing an allocation involves the so-called Monte Carlo simulation. This simulator helps you determine what would have happened with your portfolio if you were invested according to a particular mix of assets. Three main parameters you should consider for each asset class are: the asset’s historical performance, its volatility, and its correlation to other asset classes. Continue reading...

Should I invest in gold?

Gold can provide diversification in a simple way, since it has a history of being generally non-correlated with most other asset classes. It is not necessarily a hedge against anything specific, as some claim, since its price movement is too random. Conventional wisdom says that investing in gold might be a good hedge against inflation or market cataclysms. Some of these beliefs are unfounded. The price of gold appears to go up only when it is in high demand (such as when the price has gone up some already), rather than in tandem to any specific market force such as inflation or interest rates. If investors have some idea of when other investors are going to pile in, such as during times of uncertainty, they will likely be able to ride an uptrend in gold prices for a while. Continue reading...

What are Double and Triple ETFs?

Double and triple ETFs are also known as leveraged ETFs, and their goal is to magnify the performance of the index they follow. Using futures contracts and other derivative instruments, 2x or 3x ETFs attempt to magnify the performance of an index, with the goal of achieving the result daily. Because they also compound daily, they are not usually held for more than a few days. These are also called leveraged ETFs because they use margin, futures contracts, and other derivative instruments to give an investor this magnified exposure. They give you two or three times (respectively) the profits but also two or three times the losses, so one must be very cautious when dealing with them. Continue reading...

What is defined as a market correction?

Sometimes a stock or index will reflect prices that have become inflated or overvalued in the short-term as a result of bullish conditions. In some cases, due to shift in sentiment or a negative news story in the headlines, stocks may retreat suddenly and without notice. A market correction is a sharp, sudden decline in stock prices, where they fall in value by around 10% - 20% over a short period, usually no longer than 6 months. Corrections are frequent occurrences (typically an average of once a year) and are a normal and healthy part of equity investing. Continue reading...

What is a market neutral fund?

Market neutral funds might be hedge funds or mutual funds or ETFs whose strategy is not based on bullish or bearish market predictions but instead seeks to be in a position to profit whether the market goes up or down. Most mutual funds and ETFs out there are inherently bullish — you invest in those funds because you believe or hope that the industry or geographic region or cap-size that they invest in will grow in the future. Some funds offer bears a place to hole-up when the bubble inevitably bursts (or so they think). Continue reading...

What is negative correlation, and how is it different from positive correlation?

Venture into the intricate realm of negative correlation, a cornerstone of financial strategy. This deep dive unravels the mechanics behind this statistical phenomenon, its role in portfolio diversification, and its broader implications in macroeconomics. By understanding the dance between inversely related variables, investors can craft resilient portfolios and navigate market turbulence. Whether you're a seasoned financial expert or a budding investor, this exploration offers valuable insights into risk management and the art of diversification. Equip yourself with the knowledge to harness the power of negative correlation and steer your investments towards success. Continue reading...

What are Core Mutual Funds?

Core mutual funds represent the middle ground between Value and Growth, but are not the same as Blend funds. Core Mutual Funds are in between Growth and Value funds. In other words, companies in their portfolio have Price to Earnings ratios which are higher than those of Value companies but lower than those of Growth companies. This category is essentially based on the 9-box Morningstar categorization system, which separates equity funds into Small, Mid and Large Cap on the vertical axis and Value, Core, and Growth on the horizontal axis. Continue reading...

What does Arbitrage Mean?

Arbitrage is the practice of buying a security/product in one market and selling it in another, in an effort to capitalize on price difference. Arbitrage can take many forms in trading: buying a security in one market and selling it in another for a better price (market arbitrage); borrowing money in one currency at a lower interest rate in order to pay off debt in another currency with a higher interest rate (currency arbitrage); buying and selling the same security on different exchanges or between spot prices of a security and its future contract; and so on. Continue reading...