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.
Ironically, for all the talk of how “abnormal” the trading environment was in August, our measure of risk on/risk off days was far more “normal” than in previous months. (If you need a refresher, we broke down the risk on/risk off trade earlier this year.) With most markets remaining in a narrow trading range, there just weren’t many big moves, keeping the daily average well within our +/- 1.00% threshold. Overall, the average daily % change across our grouping of “risk on” markets was 0.17% for August, compared to an average of 0.03% during the first 7 months of the year. Of the 23 trading days in the month, one was a “risk off” day and two were “risk on” days. As a result, the year-to-date percentage of “normal” trading day edged upward in July, from 77.2% to 78.6% (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.
The risk on/risk off trade was less severe last month – 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.
The overall market correlation in the markets we track was also lower than in the past few months, coming in at .294 (based on the absolute value of all market correlations). This puts it closer to the overall 2012 average correlation of .271.
