Correlation Between Dow Jones and ACME Lithium

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

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

Diversification Opportunities for Dow Jones and ACME Lithium

0.61

Correlation Coefficient

Dow Jones  ACME Lithium

Poor diversification

The 3 months correlation between Dow and ACME is 0.61. Overlapping area represents the amount of risk that can be diversified away by holding Dow Jones Industrial and ACME Lithium in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on ACME Lithium and Dow Jones 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 Jones Industrial are associated (or correlated) with ACME Lithium. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of ACME Lithium has no effect on the direction of Dow Jones i.e., Dow Jones and ACME Lithium go up and down completely randomly.

Pair Corralation between Dow Jones and ACME Lithium

Assuming the 90 days trading horizon Dow Jones Industrial is expected to under-perform the ACME Lithium. But the index apears to be less risky and, when comparing its historical volatility, Dow Jones Industrial is 22.86 times less risky than ACME Lithium. The index trades about -0.01 of its potential returns per unit of risk. The ACME Lithium is currently generating about 0.11 of returns per unit of risk over similar time horizon. If you would invest  2.15  in ACME Lithium on December 28, 2024 and sell it today you would earn a total of  0.65  from holding ACME Lithium or generate 30.23% return on investment over 90 days.

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

Dow Jones Industrial  vs.  ACME Lithium

Pair Trading with Dow Jones and ACME Lithium

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

The idea behind Dow Jones Industrial and ACME Lithium 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 Risk-Return Analysis module to view associations between returns expected from investment and the risk you assume.