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 Low 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

0.9
  Correlation Coefficient

Almost no diversification

The 3 months correlation between SP 500 and DOW is 0.9. Overlapping area represents the amount of risk that can be diversified away by holding SP 500 Low 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 Low 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

Given the investment horizon of 90 days SP 500 Low is expected to generate 0.88 times more return on investment than DOW. However, SP 500 Low is 1.13 times less risky than DOW. It trades about -0.27 of its potential returns per unit of risk. DOW is currently generating about -0.33 per unit of risk. If you would invest  6,428  in SP 500 Low on June 28, 2022 and sell it today you would lose (362.00)  from holding SP 500 Low or give up 5.63% of portfolio value over 90 days.
Time Period3 Months [change]
DirectionMoves Together 
StrengthVery Strong
Accuracy100.0%
ValuesDaily Returns

SP 500 Low  vs.  DOW

 Performance (%) 
       Timeline  

SP 500 and DOW Volatility Contrast

   Predicted Return Density   
       Returns  

SP 500 Low

Pair trading matchups for 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 Low.

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 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.
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 Low.
The idea behind SP 500 Low 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 Bond Analysis module to evaluate and analyze corporate bonds as a potential investment for your portfolios..

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