# What is the difference between R-square and correlation?

R-squared is a statistical analysis of the practical use and reliability of beta (and alpha) correlation of securities. While correlation is a measure of Association between any two securities R-squared measures the security against an established benchmark or index, such as the comparison of bonds with total bond index in comparison to compare it with Standard & Poor’s 500.

The former example gives you a good idea about how bond acts against other securities in its kind (it is safe), and the second gives little useful information. R-squared is a powerful tool in Economics, not only because it measures the difference in the usefulness of such correlations, but because it gives them numerical values.

Understanding R-squared

R-squared determines the practical significance of the correlations on a percentage scale from 0 to 100. High R-squared (between 85 and 100) indicates that the pattern of performance security is closely linked to the chosen index. Low R-square (anything below 70) indicates that there is very little connection between the pattern safety indicators and index.

For example, some companies mutual Fund report R-squared of installed tools in the marketing literature, while others do not. Yahoo! Finance and Morningstar to calculate and publish the R-squared data, as well as beta figures on a daily basis.

Comparing the R-square Correlation

The correlation, however, is measured on a scale from -1 to 1 and shows a sample run of any two securities against each other. A correlation close to 1 indicates that as one security increases or falls in price, the other behaves exactly the same. Correlation equal to 0 means that there is no connection in the behavior of securities. A correlation close to -1 indicates that as one rises, the other decreases proportionally.

To find two perfectly correlated securities is unlikely, so most are between -1 and 1.

Readings less than 1.0 indicate the security is less volatile than the benchmark, while readings of exactly 1.0 indicate the price will move with the benchmark. Finally, values above 1.0 are indicative of assets more volatile than the benchmark.

Alpha is a measure of risk-adjusted performance of the Fund or assets compared to the benchmark index. An alpha of 1.0 indicates that the security exceeds the rate of 1%. Alpha is less than 0 means that the portfolio returned less than in the test. This measure is often regarded as a key performance indicator for the Fund Manager.

Bottom Line

Funds with high R-squared, alpha and beta readings are usually regarded as attractive investments because of their ability to appreciate in price because of their high correlation with known reference points can facilitate further movement to predict.

Investors should note that funds with a high beta will tend to grow faster than their performance in bull markets and drop more sharply in bear market. Over several market cycles, a Fund with a high beta may be unstable, producing a considerable profit. Funds with high R-squared, alpha and beta reader are able to assess how much and more related indicators as criteria and also to assess.