Can any of the company-specific risk be diversified away by investing in both Meta Platforms 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 Meta Platforms and Merck into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between Meta Platforms and Merck Company, you can compare the effects of market volatilities on Meta Platforms 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 Meta Platforms with a short position of Merck. Check out your portfolio center. Please also check ongoing floating volatility patterns of Meta Platforms and Merck.
Diversification Opportunities for Meta Platforms and Merck
The 3 months correlation between Meta and Merck is -0.66. Overlapping area represents the amount of risk that can be diversified away by holding Meta Platforms and Merck Company in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Merck Company and Meta Platforms 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 Meta Platforms 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 Meta Platforms i.e., Meta Platforms and Merck go up and down completely randomly.
Given the investment horizon of 90 days Meta Platforms is expected to generate 1.4 times more return on investment than Merck. However, Meta Platforms is 1.4 times more volatile than Merck Company. It trades about 0.18 of its potential returns per unit of risk. Merck Company is currently generating about 0.04 per unit of risk. If you would invest 31,087 in Meta Platforms on September 3, 2023 and sell it today you would earn a total of 1,395 from holding Meta Platforms or generate 4.49% return on investment over 90 days.
Compared to the overall equity markets, risk-adjusted returns on investments in Meta Platforms are ranked lower than 6 (%) of all global equities and portfolios over the last 90 days. Despite somewhat unfluctuating basic indicators, Meta Platforms may actually be approaching a critical reversion point that can send shares even higher in January 2024.
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 Meta Platforms and Merck positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if Meta Platforms 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 Meta Platforms 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 Positions Ratings module to determine portfolio positions ratings based on digital equity recommendations. Macroaxis instant position ratings are based on combination of fundamental analysis and risk-adjusted market performance.
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