Can any of the company-specific risk be diversified away by investing in both Western Investment and TSX Industrials 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 Western Investment and TSX Industrials into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between Western Investment and TSX Industrials Capped, you can compare the effects of market volatilities on Western Investment and TSX Industrials 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 Western Investment with a short position of TSX Industrials. Check out your portfolio center. Please also check ongoing floating volatility patterns of Western Investment and TSX Industrials.
Diversification Opportunities for Western Investment and TSX Industrials
The 3 months correlation between Western and TSX is -0.34. Overlapping area represents the amount of risk that can be diversified away by holding Western Investment and TSX Industrials Capped in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on TSX Industrials Capped and Western Investment 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 Western Investment are associated (or correlated) with TSX Industrials. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of TSX Industrials Capped has no effect on the direction of Western Investment i.e., Western Investment and TSX Industrials go up and down completely randomly.
Pair Corralation between Western Investment and TSX Industrials
Given the investment horizon of 90 days Western Investment is expected to generate 4.95 times more return on investment than TSX Industrials. However, Western Investment is 4.95 times more volatile than TSX Industrials Capped. It trades about 0.03 of its potential returns per unit of risk. TSX Industrials Capped is currently generating about -0.01 per unit of risk. If you would invest 35.00 in Western Investment on August 30, 2023 and sell it today you would earn a total of 5.00 from holding Western Investment or generate 14.29% return on investment over 90 days.
Pair Trading with Western Investment and TSX Industrials
The main advantage of trading using opposite Western Investment and TSX Industrials positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if Western Investment position performs unexpectedly, TSX Industrials 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 TSX Industrials will offset losses from the drop in TSX Industrials' long position.
The idea behind Western Investment and TSX Industrials Capped 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 Idea Optimizer module to use advanced portfolio builder with pre-computed micro ideas to build optimal portfolio .
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