Can any of the company-specific risk be diversified away by investing in both Ford and Merck 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 Ford and Merck into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between Ford Motor and Merck Company, you can compare the effects of market volatilities on Ford and Merck 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 Ford with a short position of Merck. Check out your portfolio center. Please also check ongoing floating volatility patterns of Ford and Merck.
The 3 months correlation between Ford and Merck is 0.65. Overlapping area represents the amount of risk that can be diversified away by holding Ford Motor and Merck Company in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Merck Company and Ford 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 Ford Motor are associated (or correlated) with Merck. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Merck Company has no effect on the direction of Ford i.e., Ford and Merck go up and down completely randomly.
Taking into account the 90-day investment horizon Ford Motor is expected to under-perform the Merck. In addition to that, Ford is 2.2 times more volatile than Merck Company. It trades about -0.02 of its total potential returns per unit of risk. Merck Company is currently generating about 0.07 per unit of volatility. If you would invest 6,998 in Merck Company on September 5, 2023 and sell it today you would earn a total of 3,348 from holding Merck Company or generate 47.84% return on investment over 90 days.
Over the last 90 days Ford Motor has generated negative risk-adjusted returns adding no value to investors with long positions. Despite latest weak performance, the Stock's technical and fundamental indicators remain stable and the current disturbance on Wall Street may also be a sign of long-run gains for the company stockholders.
Over the last 90 days Merck Company has generated negative risk-adjusted returns adding no value to investors with long positions. Despite quite persistent basic indicators, Merck is not utilizing all of its potentials. The latest stock price mess, may contribute to short-term losses for the institutional investors.
The main advantage of trading using opposite Ford and Merck positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if Ford position performs unexpectedly, Merck 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 Merck will offset losses from the drop in Merck's long position.
The idea behind Ford Motor and Merck Company 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 Portfolio Center module to all portfolio management and optimization tools to improve performance of your portfolios.
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