Correlation Between DOW and Chroma

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

Diversification Opportunities for DOW and Chroma

0.59
  Correlation Coefficient

Very weak diversification

The 3 months correlation between DOW and Chroma is 0.59. Overlapping area represents the amount of risk that can be diversified away by holding DOW and Chroma in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Chroma 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 Chroma. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Chroma has no effect on the direction of DOW i.e., DOW and Chroma go up and down completely randomly.
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Pair Corralation between DOW and Chroma

Given the investment horizon of 90 days DOW is expected to under-perform the Chroma. But the index apears to be less risky and, when comparing its historical volatility, DOW is 9.37 times less risky than Chroma. The index trades about -0.03 of its potential returns per unit of risk. The Chroma is currently generating about 0.01 of returns per unit of risk over similar time horizon. If you would invest  35.00  in Chroma on June 29, 2022 and sell it today you would lose (18.00)  from holding Chroma or give up 51.43% of portfolio value over 90 days.
Time Period3 Months [change]
DirectionMoves Together 
StrengthWeak
Accuracy63.73%
ValuesDaily Returns

DOW  vs.  Chroma

 Performance (%) 
       Timeline  

DOW and Chroma 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 Chroma

The main advantage of trading using opposite DOW and Chroma positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if DOW position performs unexpectedly, Chroma 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 Chroma will offset losses from the drop in Chroma'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 Chroma 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.
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 Probability Of Bankruptcy module to get analysis of equity chance of financial distress in the next 2 years.

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