Correlation Between Main Street and DOW

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

Diversification Opportunities for Main Street and DOW

0.87
  Correlation Coefficient

Very poor diversification

The 3 months correlation between Main Street and DOW is 0.87. Overlapping area represents the amount of risk that can be diversified away by holding Main Street Capital and DOW in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on DOW and Main Street 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 Main Street Capital 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 Main Street i.e., Main Street and DOW go up and down completely randomly.
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Pair Corralation between Main Street and DOW

Given the investment horizon of 90 days Main Street Capital is expected to generate 1.49 times more return on investment than DOW. However, Main Street is 1.49 times more volatile than DOW. It trades about 0.03 of its potential returns per unit of risk. DOW is currently generating about 0.0 per unit of risk. If you would invest  2,761  in Main Street Capital on July 2, 2022 and sell it today you would earn a total of  603.00  from holding Main Street Capital or generate 21.84% return on investment over 90 days.
Time Period3 Months [change]
DirectionMoves Together 
StrengthStrong
Accuracy100.0%
ValuesDaily Returns

Main Street Capital  vs.  DOW

 Performance (%) 
       Timeline  

Main Street and DOW Volatility Contrast

   Predicted Return Density   
       Returns  

Main Street Capital

Pair trading matchups for Main Street

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 Main Street and DOW

The main advantage of trading using opposite Main Street and DOW positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if Main Street 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.
Main Street vs. Boeing Company
The idea behind Main Street Capital 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.
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 Analyst Recommendations module to analyst recommendations and target price estimates broken down by several categories.

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