Weekend Market School

Today's Lesson: Pearson correlation (r)

Hello friends, welcome to our weekend stock market school! Today we will learn about a measure that we encounter everywhere in the market but often makes us say "what was that?":Pearson correlation (r). Don't worry, without getting into the mathematical atmosphere, let's start with a story.

1. What is it?

Think of two dancers. If one steps to the right and the other also steps to the right, there is perfect harmony. If one steps to the right while the other steps to the left, they are dancing in completely opposite directions. If one is dancing while the other is doing their own thing... there is no harmony, everyone is in their own rhythm.

And that's exactly what Pearson correlation (r) measures:It expresses the direction and strength of two series moving together, with a number between -1 and +1.

So the answer to the question:What does r=0.82 tell us? + A value quite close to 1. That is, the two seriesmoving strongly in the same direction moving together. One rises while the other most likely rises as well. High correlation, obvious movement together.

2. Why is it important?

This small number gives investors three big benefits:

• Diversification Awareness: Buying two assets that move in the same direction doesn't reduce risk; it's like putting two eggs in the same basket. Low or negatively correlated assets provide balance.

• Index Relationship: Is the stock moving with the market or against it? r summarizes this in a single number.

• Scenario Building: " It gives a crude but useful answer to the question: "What happens if the market rises?"

3. How to Read / Use?

Let’s go step by step:

1. Look at the sign: Plus (+) means same direction, minus (-) means opposite direction.
2. Look at the magnitude: Generally accepted thresholds are:

• Near 0 (between 0 and 0.30): weak relationship

• Between 0.30 – 0.70: moderate relationship

• 0.70 and above: strong relationship
  3. Look at the context: r doesn't say "why", it only says "move together."
  4. It's temporary: Correlation changes over time; in volatile markets, many assets can fall at the same time.

For the curious: a quick note: r squared (r²) shows how much of the movement in two series can be explained together. For example, for r=0.82, r² is approximately 0.67; meaning about two-thirds of the variation can be explained by common movement.

4. Real Example

Let's read the r values in today's three most active stocks together:

• DSTKF: Last price 694.00 TL, daily -9.99% change, channel 7%, r=-0.47. Medium level negative relationship: when the compared series rises, this stock tends to move in the opposite direction most of the time. However, -0.47 is below the "strong" threshold (-0.70); the relationship is noticeable but not absolute.

• SASA: Last price 1.92 TL, daily +6.67% change, channel 9%, r=-0.41. Again medium level negative, relationship similar to DSTKF but slightly weaker inverse relationship.

• VAKBN: Last price 33.92 TL, daily +5.15% change, channel 41%, r=0.72. Just above the strong threshold: strong positive relationship. This stock likely tends to move in the same direction as the compared series.

Note: Although r=0.72 for VAKBN, the channel is 41%. So the relationship may be strong but volatility is also high. Correlation alone doesn't tell the whole story; it's read together with accompanying information.

5. Common Mistakes

• Mistaking correlation for causation: r=0.90 doesn't mean "one affects the other." It just means they move together.

• Thinking correlation is permanent: Yesterday's r won't be the same as tomorrow's movement. Correlations typically change during periods of crisis.

• Looking only at the sign: A negative but weak r (-0.20) carries less information than a strong positive r. The magnitude as well as the sign is important.

• Using r alone as a decision tool: r without information like channel width, daily change, and volatility is half a whole.

6. Mini Test

Question 1: A friend said "the correlation between these two stocks is r=0.82". How would you explain this to them in one sentence?

Answer: " There is a strong positive relationship; these two stocks are likely to move in the same direction.

Question 2: If you add two assets with r=-0.90 to your portfolio, what does this mean in terms of diversification?

Answer: Strong inverse relationship; one tends to fall when the other rises, which could balance your portfolio. However, this is not guaranteed as the relationship can change over time.

Question 3: In today's data, r=0.72 for VAKBN. How would you classify this value?

Answer: Since values of 0.70 and above are considered "strong", VAKBN has a strong positive relationship with the series it's compared to; high tendency to move in the same direction.

7. Summary

• Pearson correlation (r) measures the co-movement of two series- between -1 and +1 .

• + same direction; - opposite direction; values approaching 0 indicate a weak relationship.

• r=0.82, is a strong positive correlation: the two series likely move together in the same direction.

• Correlation is not causation and can change over time.

• Never evaluate r in isolation; always consider it with other information like volatility, channels, and daily change.

See you in our next lesson, take care!

This lesson is for educational purposes, not investment advice.