Correlation Between NYSE Composite and Small Cap

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

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

Diversification Opportunities for NYSE Composite and Small Cap

0.83

Correlation Coefficient

NYSE Composite  Small Cap

Very poor diversification

The 3 months correlation between NYSE and Small is 0.83. Overlapping area represents the amount of risk that can be diversified away by holding NYSE Composite and Small Cap Growth in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Small Cap Growth and NYSE Composite 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 NYSE Composite 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 Growth has no effect on the direction of NYSE Composite i.e., NYSE Composite and Small Cap go up and down completely randomly.

Pair Corralation between NYSE Composite and Small Cap

Assuming the 90 days trading horizon NYSE Composite is expected to under-perform the Small Cap. But the index apears to be less risky and, when comparing its historical volatility, NYSE Composite is 1.78 times less risky than Small Cap. The index trades about -0.03 of its potential returns per unit of risk. The Small Cap Growth is currently generating about 0.02 of returns per unit of risk over similar time horizon. If you would invest  2,248  in Small Cap Growth on September 30, 2024 and sell it today you would earn a total of  26.00  from holding Small Cap Growth or generate 1.16% return on investment over 90 days.

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

NYSE Composite  vs.  Small Cap Growth

Pair Trading with NYSE Composite and Small Cap

The main advantage of trading using opposite NYSE Composite and Small Cap positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if NYSE Composite 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 NYSE Composite and Small Cap Growth 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.