Question:

How to use the correlation coefficient?

Answer:

Some explanation regarding the correlation coefficient is here: http://www.neatideas.com/cc.htm

However you should be very cautious using this coefficient. I�ll show you one example of incorrect usage of correlation.

Suppose you have got the projection line that correlates with the price (or, to be exact, with some price oscillator) 75%.

Here they are:

The question is: can we rely on this information? Maybe the downward movement of these two curves (black and red) is the result of some casual coincidence�

Yes, it is exactly so.�� And this is the most typical mistake.

Let�s look at these curves in a bit wider time frame:

Now you can see that it was just occasion that both these curves follow the same trend. To eliminate this problem, we should allow our projection line to change the direction several times.

So the practical rule in using correlation is � the oscillator you research should make several full cycles, like this:

Here our projection line makes 5 full cycles