Correlation Between DOW and SP 500

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Can any of the company-specific risk be diversified away by investing in both DOW and SP 500 at the same time? Although using a correlation coefficient on its own may not help to predict future stock returns, this module helps to understand the diversifiable risk of combining DOW and SP 500 into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between DOW and SP 500, you can compare the effects of market volatilities on DOW and SP 500 and check how they will diversify away market risk if combined in the same portfolio for a given time horizon. You can also utilize pair trading strategies of matching a long position in DOW with a short position of SP 500. Check out your portfolio center. Please also check ongoing floating volatility patterns of DOW and SP 500.

Diversification Opportunities for DOW and SP 500

0.99
  Correlation Coefficient

No risk reduction

The 3 months correlation between DOW and SP 500 is 0.99. Overlapping area represents the amount of risk that can be diversified away by holding DOW and S&P 500 in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on SP 500 and DOW is a relative statistical measure of the degree to which these equity instruments tend to move together. The correlation coefficient measures the extent to which returns on DOW are associated (or correlated) with SP 500. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of SP 500 has no effect on the direction of DOW i.e., DOW and SP 500 go up and down completely randomly.
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Pair Corralation between DOW and SP 500

Given the investment horizon of 90 days DOW is expected to generate 0.67 times more return on investment than SP 500. However, DOW is 1.49 times less risky than SP 500. It trades about 0.04 of its potential returns per unit of risk. SP 500 is currently generating about -0.08 per unit of risk. If you would invest  2,607,530  in DOW on April 1, 2022 and sell it today you would earn a total of  455,583  from holding DOW or generate 17.47% return on investment over 90 days.
Time Period3 Months [change]
DirectionMoves Together 
StrengthVery Strong
Accuracy32.33%
ValuesDaily Returns

DOW  vs.  S&P 500

 Performance (%) 
      Timeline 

DOW and SP 500 Volatility Contrast

 Predicted Return Density 
      Returns 

DOW

Pair trading matchups for DOW

Visa vs. DOW
Sentinelone Inc vs. DOW
Cleveland Cliffs vs. DOW
Dupont Denemours vs. DOW
Otp Bank vs. DOW
Salesforce vs. DOW
Vmware vs. DOW
GM vs. DOW
Pennantpark Investme vs. DOW
Pacific Gas vs. DOW
Brenmiller Energy vs. DOW
The effect of pair diversification on risk is to reduce it, but we should note this doesn't apply to all risk types. When we trade pairs against DOW as a counterpart, there is always some inherent risk that will never be diversified away no matter what. This volatility limits the effect of tactical diversification using pair trading. DOW's systematic risk is the inherent uncertainty of the entire market, and therefore cannot be mitigated even by pair-trading it against the equity that is not highly correlated to it. On the other hand, DOW's unsystematic risk describes the types of risk that we can protect against, at least to some degree, by selecting a matching pair that is not perfectly correlated to DOW.

SP 500

Pair trading matchups for SP 500

Pennantpark Investme vs. SP 500
Alphabet vs. SP 500
Ford vs. SP 500
Cleveland Cliffs vs. SP 500
Otp Bank vs. SP 500
Dupont Denemours vs. SP 500
GM vs. SP 500
Brenmiller Energy vs. SP 500
Salesforce vs. SP 500
Visa vs. SP 500
The effect of pair diversification on risk is to reduce it, but we should note this doesn't apply to all risk types. When we trade pairs against SP 500 as a counterpart, there is always some inherent risk that will never be diversified away no matter what. This volatility limits the effect of tactical diversification using pair trading. SP 500's systematic risk is the inherent uncertainty of the entire market, and therefore cannot be mitigated even by pair-trading it against the equity that is not highly correlated to it. On the other hand, SP 500's unsystematic risk describes the types of risk that we can protect against, at least to some degree, by selecting a matching pair that is not perfectly correlated to SP 500.

Pair Trading with DOW and SP 500

The main advantage of trading using opposite DOW and SP 500 positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if DOW position performs unexpectedly, SP 500 can make up some of the losses. Pair trading also minimizes risk from directional movements in the market. For example, if an entire industry or sector drops because of unexpected headlines, the short position in SP 500 will offset losses from the drop in SP 500's long position.

DOW

Pair trading matchups for DOW

Ford vs. DOW
Visa vs. DOW
Cleveland Cliffs vs. DOW
Dupont Denemours vs. DOW
Pacific Gas vs. DOW
Brenmiller Energy vs. DOW
Vmware vs. DOW
Otp Bank vs. DOW
Sentinelone Inc vs. DOW
Pennantpark Investme vs. DOW
The effect of pair diversification on risk is to reduce it, but we should note this doesn't apply to all risk types. When we trade pairs against DOW as a counterpart, there is always some inherent risk that will never be diversified away no matter what. This volatility limits the effect of tactical diversification using pair trading. DOW's systematic risk is the inherent uncertainty of the entire market, and therefore cannot be mitigated even by pair-trading it against the equity that is not highly correlated to it. On the other hand, DOW's unsystematic risk describes the types of risk that we can protect against, at least to some degree, by selecting a matching pair that is not perfectly correlated to DOW.
The idea behind DOW and SP 500 pairs trading is to make the combined position market-neutral, meaning the overall market's direction will not affect its win or loss (or potential downside or upside). This can be achieved by designing a pairs trade with two highly correlated stocks or equities that operate in a similar space or sector, making it possible to obtain profits through simple and relatively low-risk investment.

SP 500

Pair trading matchups for SP 500

Ford vs. SP 500
Salesforce vs. SP 500
Otp Bank vs. SP 500
Alphabet vs. SP 500
Cleveland Cliffs vs. SP 500
Brenmiller Energy vs. SP 500
Cia DE vs. SP 500
Pacific Gas vs. SP 500
Visa vs. SP 500
Citigroup vs. SP 500
The effect of pair diversification on risk is to reduce it, but we should note this doesn't apply to all risk types. When we trade pairs against SP 500 as a counterpart, there is always some inherent risk that will never be diversified away no matter what. This volatility limits the effect of tactical diversification using pair trading. SP 500's systematic risk is the inherent uncertainty of the entire market, and therefore cannot be mitigated even by pair-trading it against the equity that is not highly correlated to it. On the other hand, SP 500's unsystematic risk describes the types of risk that we can protect against, at least to some degree, by selecting a matching pair that is not perfectly correlated to SP 500.
Check out your portfolio center. Note that this page's information should be used as a complementary analysis to find the right mix of equity instruments to add to your existing portfolios or create a brand new portfolio. You can also try Piotroski F Score module to get Piotroski F Score based on binary analysis strategy of nine different fundamentals.

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