This segment focuses on correlations of the market at different times but especially so under periods of a large increase in implied volatility and what that means for your portfolio. This is important information that every trader needs to know.
When managing our portfolio we make sure we are not too exposed to an individual stock or stock sector. A problem to overcome is that when volatility has a strong jump up the correlations between stocks increases. The question then is, why does this happen and how can protect ourselves?
We calculated the 1-month correlation for the top 100 stocks in the S&P 500, against the index. We plotted the average correlation and the 1 standard deviation range through a period of stock volatility. A chart displayed the results.
Traders enter a “risk-off” mindset when the market makes a hard down move and sell almost everything. That’s why the correlation moves towards 1.0 and everything seems to be correlated. As a result, diversifying positions does little to nothing. We also must have diversified strategies. Tom and Tony explain what that means.
Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista for the takeaways and other important information about market correlations and how to guard your portfolio when everything is moving together.
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