Correlation Between DOW and Taiwan Semiconductor

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

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

Diversification Opportunities for DOW and Taiwan Semiconductor

0.41
  Correlation Coefficient
DOW
Taiwan Semiconductor

Very weak diversification

The 3 months correlation between DOW and Taiwan is 0.41. Overlapping area represents the amount of risk that can be diversified away by holding DOW and Taiwan Semiconductor Manufactu in the same portfolio assuming nothing else is changed. The correlation between historical prices or returns on Taiwan Semiconductor and DOW 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 are associated (or correlated) with Taiwan Semiconductor. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Taiwan Semiconductor has no effect on the direction of DOW i.e., DOW and Taiwan Semiconductor go up and down completely randomly.
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Pair Corralation between DOW and Taiwan Semiconductor

Given the investment horizon of 90 days DOW is expected to generate 3.28 times less return on investment than Taiwan Semiconductor. But when comparing it to its historical volatility, DOW is 1.45 times less risky than Taiwan Semiconductor. It trades about 0.03 of its potential returns per unit of risk. Taiwan Semiconductor Manufacturing is currently generating about 0.08 of returns per unit of risk over similar time horizon. If you would invest  5,347  in Taiwan Semiconductor Manufacturing on September 1, 2021 and sell it today you would earn a total of  6,368  from holding Taiwan Semiconductor Manufacturing or generate 119.09% return on investment over 90 days.
Time Period3 Months [change]
DirectionMoves Together 
StrengthWeak
Accuracy100.0%
ValuesDaily Returns

DOW  vs.  Taiwan Semiconductor Manufactu

 Performance (%) 
      Timeline 

DOW and Taiwan Semiconductor Volatility Contrast

 Predicted Return Density 
      Returns 

DOW

Pair trading matchups for DOW

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The effect of pair diversification on risk is to reduce it, but we should note this doesn't apply to all risk types. When we trade pairs against DOW as a counterpart, there is always some inherent risk that will never be diversified away no matter what. This volatility limits the effect of tactical diversification using pair trading. DOW's systematic risk is the inherent uncertainty of the entire market, and therefore cannot be mitigated even by pair-trading it against the equity that is not highly correlated to it. On the other hand, DOW's unsystematic risk describes the types of risk that we can protect against, at least to some degree, by selecting a matching pair that is not perfectly correlated to DOW.

Pair Trading with DOW and Taiwan Semiconductor

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

DOW

Pair trading matchups for DOW

GM vs. DOW
Salesforce vs. DOW
Sentinelone Inc vs. DOW
Ford vs. DOW
Microsoft Corp vs. DOW
Visa vs. DOW
Meta Platforms vs. DOW
The effect of pair diversification on risk is to reduce it, but we should note this doesn't apply to all risk types. When we trade pairs against DOW as a counterpart, there is always some inherent risk that will never be diversified away no matter what. This volatility limits the effect of tactical diversification using pair trading. DOW's systematic risk is the inherent uncertainty of the entire market, and therefore cannot be mitigated even by pair-trading it against the equity that is not highly correlated to it. On the other hand, DOW's unsystematic risk describes the types of risk that we can protect against, at least to some degree, by selecting a matching pair that is not perfectly correlated to DOW.
The idea behind DOW and Taiwan Semiconductor Manufacturing 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 Price Exposure Probability module to analyze equity upside and downside potential for a given time horizon across multiple markets.

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