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Monday, November 11, 2024

How to Look for Sectors with Little to No Correlation ?

By Century Financial in 'Blog'

How to Look for Sectors with Little to No...
Look for Sectors with little or no Correlation

When building a strong investment portfolio, diversification is the key. But not all diversification is effective. To truly diversify, you need to identify sectors with low or no correlation.

In this guide, we’ll explain how you can find these sectors and use them to build a more resilient portfolio.

Why is Sector Correlation Important?

Correlation measures how two assets move in relation to each other. It ranges between -1 and +1:

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+1: Perfectly correlated (they move in the same direction).
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0: No correlation (they move independently).
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-1: Perfectly inversely correlated (one rises while the other falls).

When different sectors exhibit low or no correlation, market downturns in one sector may not significantly affect others. This helps reduce risk and smooth returns over time to avoid volatility.

1

Choose a Few Key Sectors to Compare

Start with sectors like:

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Technology (e.g., Apple, Google)
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Healthcare (e.g., Pfizer, Johnson & Johnson)
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Energy (e.g., ExxonMobil)
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Consumer Staples (e.g., Procter & Gamble)
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Utilities (e.g., Duke Energy)

These sectors have distinct drivers and are less likely to move in sync with one another.

2

Use Free Tools to Compare Sector Performance

Retail investors can easily access free platforms to compare correlations:

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Yahoo Finance: Overlay sector-specific ETFs (e.g., XLK for technology, XLE for energy) on a chart.
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Trading View: Use the “Compare” feature to analyze multiple sectors on the same chart visually.
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Koy fin: Provides sector-level comparisons with correlation metrics for free.

3

Download Sector Data & Calculate Correlation in Excel or Google Sheets

  1. Download historical prices of sector ETFs (like XLK, XLE, XLU) from Yahoo Finance or Google Finance.
  2. Use the CORREL function in Excel/Sheets to measure the correlation between two sectors:
  3. =CORREL(B3:B8,C3:C8)

Look for pairs with correlation close to 0 or negative values, as they indicate little or no correlation.

4

Look for Macro Drivers That Impact Sectors Differently

Different sectors respond uniquely to macroeconomic factors:

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Technology tends to thrive during periods of innovation but may struggle with rising interest rates.
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Energy responds more to oil prices and geopolitical factors than broader economic conditions.
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Utilities are defensive plays and perform well during recessions but may lag in growth markets.

Investing across sectors with varied macro drivers can reduce the impact of any single economic event on your portfolio.

5

Consider Sector-Specific ETFs for Easy Diversification

If picking individual stocks feels overwhelming, sector ETFs offer an easy way to diversify across industries. Here are a few examples:

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Power Shares DB Commodity Index Tracking Fund
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Consumer Discretionary Select Sector SPDR Fund
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Utilities Select Sector SPDR Fund
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And many more

All these funds are available on the Century Trader Platform. Adding ETFs from uncorrelated sectors ensures a well-balanced portfolio.

How to Use Correlation Data for Better Investing Decisions?

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Build a Diversified Portfolio: Include sectors that behave differently from one another.
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Monitor Correlation Periodically: Correlations change over time due to market conditions, so keep track of sector relationships.
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Use Correlation for Rebalancing: When correlations increase, consider shifting investments to maintain portfolio balance.

Example of Low-Correlation Sectors

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Technology vs. Utilities: Tech tends to perform well in booming economies, while utilities are defensive.
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Energy vs. Consumer Staples: Energy prices are volatile, but consumer staples remain stable regardless of oil prices.

These pairs offer natural diversification, helping investors reduce risk during market fluctuations.

The Bottom Line

Finding sectors with low or no correlation is an effective strategy to reduce risk and ensure more stable returns. As a retail investor, you don’t need expensive software to do this—free tools like Yahoo Finance, Trading View, and Excel are enough to help you analyze correlations.

By strategically investing in uncorrelated sectors, you can build a resilient portfolio that weathers market downturns and captures growth opportunities. Start analyzing sectors today to maximize returns while minimizing risk.

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