Correlation Between Extended Market and Small Cap

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

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

Diversification Opportunities for Extended Market and Small Cap

0.93

Correlation Coefficient

Extended Market  Small Cap

Almost no diversification

The 3 months correlation between Extended and Small is 0.93. Overlapping area represents the amount of risk that can be diversified away by holding Extended Market Index and Small Cap Stock in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Small Cap Stock and Extended Market 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 Extended Market Index are associated (or correlated) with Small Cap. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Small Cap Stock has no effect on the direction of Extended Market i.e., Extended Market and Small Cap go up and down completely randomly.

Pair Corralation between Extended Market and Small Cap

Assuming the 90 days horizon Extended Market Index is expected to generate 0.81 times more return on investment than Small Cap. However, Extended Market Index is 1.23 times less risky than Small Cap. It trades about 0.14 of its potential returns per unit of risk. Small Cap Stock is currently generating about 0.08 per unit of risk. If you would invest  2,261  in Extended Market Index on September 15, 2024 and sell it today you would earn a total of  199.00  from holding Extended Market Index or generate 8.8% return on investment over 90 days.

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

Extended Market Index  vs.  Small Cap Stock

Extended Market Index

Risk-Adjusted Performance

10 of 100

OK

Compared to the overall equity markets, risk-adjusted returns on investments in Extended Market Index are ranked lower than 10 (%) of all funds and portfolios of funds over the last 90 days. In spite of fairly weak forward indicators, Extended Market may actually be approaching a critical reversion point that can send shares even higher in January 2025.

Small Cap Stock

Risk-Adjusted Performance

6 of 100

Modest

Compared to the overall equity markets, risk-adjusted returns on investments in Small Cap Stock are ranked lower than 6 (%) of all funds and portfolios of funds over the last 90 days. In spite of fairly strong basic indicators, Small Cap is not utilizing all of its potentials. The current stock price disturbance, may contribute to short-term losses for the investors.

Pair Trading with Extended Market and Small Cap

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

The idea behind Extended Market Index and Small Cap Stock 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 Rebalancing module to analyze risk-adjusted returns against different time horizons to find asset-allocation targets.