Correlation Between Dow Jones and Select Sector

Can any of the company-specific risk be diversified away by investing in both Dow Jones and Select Sector 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 Select Sector 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 The Select Sector, you can compare the effects of market volatilities on Dow Jones and Select Sector 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 Select Sector. Check out your portfolio center. Please also check ongoing floating volatility patterns of Dow Jones and Select Sector.

Diversification Opportunities for Dow Jones and Select Sector

0.58

Correlation Coefficient

Dow Jones  Select Sector

Very weak diversification

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

Pair Corralation between Dow Jones and Select Sector

Assuming the 90 days trading horizon Dow Jones is expected to generate 2.33 times less return on investment than Select Sector. But when comparing it to its historical volatility, Dow Jones Industrial is 3.19 times less risky than Select Sector. It trades about 0.12 of its potential returns per unit of risk. The Select Sector is currently generating about 0.09 of returns per unit of risk over similar time horizon. If you would invest  62,809  in The Select Sector on September 4, 2024 and sell it today you would earn a total of  27,447  from holding The Select Sector or generate 43.7% return on investment over 90 days.

Time Period	3 Months [change]
Direction	Moves Together
Strength	Weak
Accuracy	84.21%
Values	Daily Returns

Dow Jones Industrial  vs.  The Select Sector

Pair Trading with Dow Jones and Select Sector

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

The idea behind Dow Jones Industrial and The Select Sector 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.

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 the Analyst Advice module to analyst recommendations and target price estimates broken down by several categories.