Correlation Between Cotton and Cocoa

Can any of the company-specific risk be diversified away by investing in both Cotton and Cocoa 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 Cotton and Cocoa into the same portfolio, which is an essential part of the fundamental portfolio management process.

By analyzing existing cross correlation between Cotton and Cocoa, you can compare the effects of market volatilities on Cotton and Cocoa 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 Cotton with a short position of Cocoa. Check out your portfolio center. Please also check ongoing floating volatility patterns of Cotton and Cocoa.

Diversification Opportunities for Cotton and Cocoa

0.58

Correlation Coefficient

Cotton  Cocoa

Very weak diversification

The 3 months correlation between Cotton and Cocoa is 0.58. Overlapping area represents the amount of risk that can be diversified away by holding Cotton and Cocoa in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Cocoa and Cotton 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 Cotton are associated (or correlated) with Cocoa. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Cocoa has no effect on the direction of Cotton i.e., Cotton and Cocoa go up and down completely randomly.

Pair Corralation between Cotton and Cocoa

Assuming the 90 days horizon Cotton is expected to generate 0.33 times more return on investment than Cocoa. However, Cotton is 3.02 times less risky than Cocoa. It trades about -0.03 of its potential returns per unit of risk. Cocoa is currently generating about -0.15 per unit of risk. If you would invest  6,848  in Cotton on December 29, 2024 and sell it today you would lose (159.00) from holding Cotton or give up 2.32% of portfolio value over 90 days.

Time Period	3 Months [change]
Direction	Moves Together
Strength	Weak
Accuracy	100.0%
Values	Daily Returns

Cotton  vs.  Cocoa

Cotton

Risk-Adjusted Performance

Very Weak

Over the last 90 days Cotton has generated negative risk-adjusted returns adding no value to investors with long positions. In spite of fairly strong basic indicators, Cotton is not utilizing all of its potentials. The latest stock price disturbance, may contribute to short-term losses for the investors.

Cocoa

Risk-Adjusted Performance

Very Weak

Over the last 90 days Cocoa has generated negative risk-adjusted returns adding no value to investors with long positions. In spite of unsteady performance in the last few months, the Commodity's basic indicators remain rather sound which may send shares a bit higher in April 2025. The latest tumult may also be a sign of longer-term up-swing for Cocoa shareholders.

Pair Trading with Cotton and Cocoa

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

The idea behind Cotton and Cocoa 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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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 the Portfolio File Import module to quickly import all of your third-party portfolios from your local drive in csv format.