R-squared is a statistical tool called a correlation coefficient. It is a percentage measurement that represents how closely correlated a security’s movement is with the movements of a benchmark index. Values range between 0 and 1 and are often expressed as percentages between 0% and 100%.
A higher R-squared (between 85% and 100%) tells investors that a security moves more or less in correlation with the benchmark index. A lower R-squared (70% or less) means that the security in question moves independently from the index.
It is also closely related to Beta, another correlative measurement and volatility indicator that denotes how closely an investment follows movements in the market as a whole, with some key differences. Beta is more concerned with the degree of difference in volatility, or the difference in rate of change when changes occur – it compares the times when a security experiences price movement and when the market as a whole (or the S&P 500) experiences price movement. Beta measures how many changes in price, and by how much, a security experiences over an amount of time.
R-squared and Beta can be used in tandem, however, to get a picture of how a security relates to a benchmark. R-squared can be used to check the validity of a beta measurement: in fact, betas will probably not have much significance unless R-squared is high.
While R-squared can examine correlation between movements of dependent and independent variables, it does not reflect data bias or discern the quality of the model being examined. That’s why savvy traders will look for additional signals to confirm – or force them to reconsider – potential trading decisions. Tickeron’s Artificial Intelligence, known as A.I.dvisor, gives traders powerful ways to evaluate trade ideas, analyze signals, and provide the key confirmation needed to make rational, emotionless, and advantageous trades.