Part of staying diversified is trading in markets that are non-correlated; this can help reduce risk and volatility. Unfortunately, when the markets move up or down in unison, achieving diversification is much more difficult, and that’s why we’ve started keeping an eye on two statistics that illustrate how easy or difficult it has been to stay diversified in the futures markets: the risk on/risk off trade, and the market correlations.

First, let’s look at how the risk on/risk off trade fared in July. (If you need a refresher, we broke down the risk on/risk off trade earlier this year.) This July was a month of ups and downs, as most markets followed a pattern of rising for 3-6 days, then falling for 3-6 days. Overall, the average daily % change across our grouping of “risk on” markets was 0.20% for July, compared to an average of 0.00% during the first 6 months of the year. Of the 21 trading days in the month, four were “risk on” days and three were “risk off” days. As we’ve been seeing pretty much all year, the percentage of “risk on” and “risk off” days continued to creep upward in July. (Disclaimer: past performance is not necessarily indicative of future results.

Risk On = average gain of over 1% for ‘risk’ assets; Risk Off = average loss of over -1% for “risk” assets.

This risk on/risk off trade doesn’t appear to be going anywhere – so what about the overall market correlations? As a refresher, correlation is a statistical measure of how interrelated two sets of data are. A correlation of 1.00 would mean that the markets move in lock-step, and a correlation of -1.00 means that they always move in opposite directions. For diversification value, what we’re looking for is non-correlation (a correlation of 0.00), which would mean that the two markets are behaving as though they are completely unrelated.

As one would expect in a month of more risk on/risk off days, the overall market correlation was higher than what we’ve seen in the rest of the year. July set a new 2012 high for overall market correlation in the markets we track, coming in at .385 (based on the absolute value of all market correlations), beating the previous high of .334 we saw in April and coming in well above the average of .277 for the first half of the year.

July didn’t exactly bring fireworks, but the markets definitely didn’t move toward “normal.” There is still diversification value to be had, but the general trend has continued to be one of more risk on/risk off days, and generally higher correlations. All the more reason to be careful out there.