Correlation Between DOW and XWC

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

Diversification Opportunities for DOW and XWC

0.13
  Correlation Coefficient

Average diversification

The 3 months correlation between DOW and XWC is 0.13. Overlapping area represents the amount of risk that can be diversified away by holding DOW and XWC in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on XWC 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 XWC. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of XWC has no effect on the direction of DOW i.e., DOW and XWC go up and down completely randomly.
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Pair Corralation between DOW and XWC

Given the investment horizon of 90 days DOW is expected to under-perform the XWC. But the index apears to be less risky and, when comparing its historical volatility, DOW is 48.23 times less risky than XWC. The index trades about -0.34 of its potential returns per unit of risk. The XWC is currently generating about 0.1 of returns per unit of risk over similar time horizon. If you would invest  17.00  in XWC on June 27, 2022 and sell it today you would lose (8.57)  from holding XWC or give up 50.41% of portfolio value over 90 days.
Time Period3 Months [change]
DirectionMoves Together 
StrengthInsignificant
Accuracy77.27%
ValuesDaily Returns

DOW  vs.  XWC

 Performance (%) 
       Timeline  

DOW and XWC 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 XWC

The main advantage of trading using opposite DOW and XWC positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if DOW position performs unexpectedly, XWC 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 XWC will offset losses from the drop in XWC'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 XWC 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 Stock Tickers module to use high-impact, comprehensive, and customizable stock tickers that can be easily integrated to any websites.

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