Correlation Between DOW and Armour Residential

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Can any of the company-specific risk be diversified away by investing in both DOW and Armour Residential 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 Armour Residential into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between DOW and Armour Residential R, you can compare the effects of market volatilities on DOW and Armour Residential 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 Armour Residential. Check out your portfolio center. Please also check ongoing floating volatility patterns of DOW and Armour Residential.

Diversification Opportunities for DOW and Armour Residential

0.81
  Correlation Coefficient

Very poor diversification

The 3 months correlation between DOW and Armour is 0.81. Overlapping area represents the amount of risk that can be diversified away by holding DOW and Armour Residential R in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Armour Residential 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 Armour Residential. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Armour Residential has no effect on the direction of DOW i.e., DOW and Armour Residential go up and down completely randomly.
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Pair Corralation between DOW and Armour Residential

Given the investment horizon of 90 days DOW is expected to generate 0.8 times more return on investment than Armour Residential. However, DOW is 1.25 times less risky than Armour Residential. It trades about -0.34 of its potential returns per unit of risk. Armour Residential R is currently generating about -0.61 per unit of risk. If you would invest  3,228,340  in DOW on June 27, 2022 and sell it today you would lose (269,299)  from holding DOW or give up 8.34% of portfolio value over 90 days.
Time Period3 Months [change]
DirectionMoves Together 
StrengthStrong
Accuracy100.0%
ValuesDaily Returns

DOW  vs.  Armour Residential R

 Performance (%) 
       Timeline  

DOW and Armour Residential Volatility Contrast

   Predicted Return Density   
       Returns  

DOW

Pair trading matchups for 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.

Pair Trading with DOW and Armour Residential

The main advantage of trading using opposite DOW and Armour Residential positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if DOW position performs unexpectedly, Armour Residential 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 Armour Residential will offset losses from the drop in Armour Residential's long position.
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 Armour Residential R 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.
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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 Equity Forecasting module to use basic forecasting models to generate price predictions and determine price momentum.

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