The Autocorrelation function is one of the widest used tools in time

series analysis. It is used to determine stationarity and seasonality.

Stationarity:

This refers to whether the series is “going anywhere” over time.

Stationary series have a constant value over time.

Below is what a non-stationary series looks like. Note the changing

mean.

Time series plot of non-stationary series

And below is what a stationary series looks like. This is the first
difference of the above series, FYI. Note the constant mean (long
term).

Stationary series: First difference of VWAP

The above time series provide strong indications of (non) stationary,

but the ACF helps us ascertain this indication.

If a series is non-stationary (moving), its ACF may look a little like

this:
ACF of non-stationary series

The above ACF is “decaying”, or decreasing, very slowly, and remains

well above the significance range (dotted blue lines). This is
indicative of a non-stationary series.

On the other hand, observe the ACF of a stationary (not going

anywhere) series:

ACF of stationary series

Note that the ACF shows exponential decay. This is indicative of a

stationary series.

Consider the case of a simple stationary series, like the process

shown below:

We do not expect the ACF to be above the significance range for lags
1, 2, … This is intuitively satisfactory, because the above process is
purely random, and therefore whether you are looking at a lag of 1 or
a lag of 20, the correlation should be theoretically zero, or at least
insignificant.

Now, let us use the ACF to determine seasonality. This is a relatively

straightforward procedure.

Firstly, seasonality in a time series refers to predictable and

recurring trends and patterns over a period of time, normally a year.
An example of a seasonal time series is retail data, which sees spikes
in sales during holiday seasons like Christmas. Another seasonal
time series is box office data, which sees a spike in sales of movie
tickets over the summer season. Yet another example is sales of
Hallmark cards, which spike in February for Valentine’s Day.

The below graphs show sales of clothing in the UK, and how these
sales follow seasonal trends, spiking in the holiday season:

Clothing Sales in the UK

Clothing Sales in the UK: line graph

Note the spikes in sales, which obediently occur every December, in

time for Christmas. This is evident in the trail of December plot
points (Graph 1), which hover significantly above the sales data for
other months, and also in the actual spikes of the line graph (Graph
2).

The above is a simple example of a seasonal time series. However,

time series are not always simply seasonal. For example, a SARMA
process comprises of seasonal, autoregressive, and moving average
components, hence the acronym. This will not look as obviously
seasonal, as the AR and MA processes may overlap with the seasonal
process. Thus, a simple time series plot, as shown above, will not
allow us to appreciate and identify the seasonal element in the series.

Thus, it may be advisable to use an autocorrelation function to

determine seasonality. In the case of seasonality, we will observe an
ACF as below:
ACF of UK clothing sales data

Note that the ACF shows an oscillation, indicative of a seasonal

series. Note the peaks occur at lags of 12 months, because April 2011
correlates with April 2012, and 24 months, because April 2011
correlates with April 2013, and so on.