Correlation Between SP 500 and DOW

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Can any of the company-specific risk be diversified away by investing in both SP 500 and DOW 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 SP 500 and DOW into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between SP 500 and DOW, you can compare the effects of market volatilities on SP 500 and DOW 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 SP 500 with a short position of DOW. Check out your portfolio center. Please also check ongoing floating volatility patterns of SP 500 and DOW.

Diversification Opportunities for SP 500 and DOW

0.97
  Correlation Coefficient

Almost no diversification

The 3 months correlation between SP 500 and DOW is 0.97. Overlapping area represents the amount of risk that can be diversified away by holding S&P 500 and DOW in the same portfolio assuming nothing else is changed. The correlation between historical prices or returns on DOW and SP 500 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 SP 500 are associated (or correlated) with DOW. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of DOW has no effect on the direction of SP 500 i.e., SP 500 and DOW go up and down completely randomly.
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Pair Corralation between SP 500 and DOW

Assuming the 90 days horizon SP 500 is expected to under-perform the DOW. In addition to that, SP 500 is 1.32 times more volatile than DOW. It trades about -0.07 of its total potential returns per unit of risk. DOW is currently generating about 0.05 per unit of volatility. If you would invest  2,540,064  in DOW on February 17, 2022 and sell it today you would earn a total of  725,395  from holding DOW or generate 28.56% return on investment over 90 days.
Time Period3 Months [change]
DirectionMoves Together 
StrengthVery Strong
Accuracy26.51%
ValuesDaily Returns

S&P 500  vs.  DOW

 Performance (%) 
      Timeline 

SP 500 and DOW Volatility Contrast

 Predicted Return Density 
      Returns 

SP 500

Pair trading matchups for SP 500

Walker Dunlop vs. SP 500
Sentinelone Inc vs. SP 500
Visa vs. SP 500
Salesforce vs. SP 500
Olin Corp vs. SP 500
Dynamic Energy vs. SP 500
Vmware vs. SP 500
Apple vs. SP 500
Microsoft Corp 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.

DOW

Pair trading matchups for DOW

Vmware vs. DOW
Salesforce vs. DOW
Citigroup vs. DOW
Sentinelone Inc vs. DOW
Olin Corp vs. DOW
Apple vs. DOW
GM vs. DOW
Ford vs. DOW
Visa vs. DOW
Microsoft Corp 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.

Pair Trading with SP 500 and DOW

The main advantage of trading using opposite SP 500 and DOW positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if SP 500 position performs unexpectedly, DOW 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 DOW will offset losses from the drop in DOW's long position.

SP 500

Pair trading matchups for SP 500

John Marshall vs. SP 500
Sentinelone Inc vs. SP 500
Dynamic Energy vs. SP 500
Citigroup vs. SP 500
Visa vs. SP 500
Microsoft Corp vs. SP 500
Vmware vs. SP 500
GM vs. SP 500
Apple 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.
The idea behind SP 500 and DOW 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.

DOW

Pair trading matchups for DOW

Visa vs. DOW
Walker Dunlop vs. DOW
Apple vs. DOW
Microsoft Corp vs. DOW
John Marshall vs. DOW
Sentinelone Inc vs. DOW
Dynamic Energy vs. DOW
Salesforce vs. DOW
GM vs. DOW
Olin Corp 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.
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 Pattern Recognition module to use different Pattern Recognition models to time the market across multiple global exchanges.

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