Currency correlation is important to understand in forex trading because it could impact your trading results often without you even knowing it.
In this post, I will share some information about correlations in forex trading and how you are able to use it to your advantage to avoid unnecessary losses. Throughout my journey as a beginner trader, I have bought or sold 2 different currency pairs many times without knowing they are negatively correlated just to let the gains be offset by
the other pair.
My aim in this short post is to bring awareness about the positive and negative correlations between the currencies, specifically the most traded major pairs in the forex market.
What is correlation in forex trading?
A foreign exchange correlation is the connection between 2 different currency pairs. There is a positive correlation when 2 pairs move in the same direction, a negative correlation when they move in opposite direction, and no correlation if the pairs move with no relationship. In order to understand the relationship between 2 currencies, you must know the correlation coefficient and how it relates.
What is correlation coefficient?
A correlation coefficient represents how strong or weak a correlation is between 2 forex pairs. They are expressed in values and range from -100 to 100 or -1 to 1, with the decimal representing the coefficient. The higher the value of the correlation coefficient will largely reflect the movement of the other pair.
See Figure 1. Correlation Heat Map
For example, If the reading is -70 and above 70, it is considered to have strong correlation between the two. Readings anywhere between -70 to 70 means that the pairs are less correlated. With coefficients near the 0 mark, means little or no relationship with one or another. As traders, implementing risk management in our trading plan also reflects to correlations as you may think its a good ides to buy 2 highly correlated pairs thinking you will double your profits when in reality you may lose double the money as both trades could end up in a loss as you're doubling your risk.
Figure 2 . Positive Correlation: EURUSD / AUDUSD
As we can see on this line chart between EURUSD / AUDUSD, both pairs have a strong correlation coefficient as they are moving in almost the same direction. The correlation coefficient is valued at 75 as noted on the heat map. For example, if you place a buy order EURUSD and place a sell order on AUDUSD, expect a win and a loss in most cases.
Figure 3. Negative Correlation: EURGBP / GBPUSD
On this line chart, we can see that both of these parts are moving in opposite directions which are showing a negative correction between the two which in fact is also known as an inverted correction. The correlation coefficient is valued at -90 on the heat map which means if you place a buy order on EURGBP and a place a sell order on GBPUSD you may double your profits, but again you're doubling your risk.
Figure 4. No Correlation: GBPJPY / USDJPY
This line chart shows that both of these pairs move in the same direction with a correlation coefficient of -9 which has almost no correlation. If you place a buy order on GBPJPY and place a sell order on USDJPY, one of these trades will most likely end up in a loss. The pairs that have no correlation usually have different and separate economic conditions therefore coefficient values tend to be lower.
In summary, understanding which pairs are correlated with one another will be able to help build your strategy and improve your trading results. Every trading strategy NEEDS to have Risk Management implemented in it as it is the key to sustainability for the long run.
Trading is a marathon NOT a sprint.
To learn more about forex correlations and their relationships, please see the following links.
References:
https://www.tradingview.com/markets/currencies/cross-rates-overview-heat-map/
https://ca.investing.com/tools/correlation-calculator
If you felt this information was helpful, and hit the LIKE button and FOLLOW me for more educational
posts and analysis.
Feel free to leave a comment if you have any questions!
I appreciate all the feedback.
Thanks
Trade Safe
In this post, I will share some information about correlations in forex trading and how you are able to use it to your advantage to avoid unnecessary losses. Throughout my journey as a beginner trader, I have bought or sold 2 different currency pairs many times without knowing they are negatively correlated just to let the gains be offset by
the other pair.
My aim in this short post is to bring awareness about the positive and negative correlations between the currencies, specifically the most traded major pairs in the forex market.
What is correlation in forex trading?
A foreign exchange correlation is the connection between 2 different currency pairs. There is a positive correlation when 2 pairs move in the same direction, a negative correlation when they move in opposite direction, and no correlation if the pairs move with no relationship. In order to understand the relationship between 2 currencies, you must know the correlation coefficient and how it relates.
What is correlation coefficient?
A correlation coefficient represents how strong or weak a correlation is between 2 forex pairs. They are expressed in values and range from -100 to 100 or -1 to 1, with the decimal representing the coefficient. The higher the value of the correlation coefficient will largely reflect the movement of the other pair.
See Figure 1. Correlation Heat Map
For example, If the reading is -70 and above 70, it is considered to have strong correlation between the two. Readings anywhere between -70 to 70 means that the pairs are less correlated. With coefficients near the 0 mark, means little or no relationship with one or another. As traders, implementing risk management in our trading plan also reflects to correlations as you may think its a good ides to buy 2 highly correlated pairs thinking you will double your profits when in reality you may lose double the money as both trades could end up in a loss as you're doubling your risk.
Figure 2 . Positive Correlation: EURUSD / AUDUSD
As we can see on this line chart between EURUSD / AUDUSD, both pairs have a strong correlation coefficient as they are moving in almost the same direction. The correlation coefficient is valued at 75 as noted on the heat map. For example, if you place a buy order EURUSD and place a sell order on AUDUSD, expect a win and a loss in most cases.
Figure 3. Negative Correlation: EURGBP / GBPUSD
On this line chart, we can see that both of these parts are moving in opposite directions which are showing a negative correction between the two which in fact is also known as an inverted correction. The correlation coefficient is valued at -90 on the heat map which means if you place a buy order on EURGBP and a place a sell order on GBPUSD you may double your profits, but again you're doubling your risk.
Figure 4. No Correlation: GBPJPY / USDJPY
This line chart shows that both of these pairs move in the same direction with a correlation coefficient of -9 which has almost no correlation. If you place a buy order on GBPJPY and place a sell order on USDJPY, one of these trades will most likely end up in a loss. The pairs that have no correlation usually have different and separate economic conditions therefore coefficient values tend to be lower.
In summary, understanding which pairs are correlated with one another will be able to help build your strategy and improve your trading results. Every trading strategy NEEDS to have Risk Management implemented in it as it is the key to sustainability for the long run.
Trading is a marathon NOT a sprint.
To learn more about forex correlations and their relationships, please see the following links.
References:
https://www.tradingview.com/markets/currencies/cross-rates-overview-heat-map/
https://ca.investing.com/tools/correlation-calculator
If you felt this information was helpful, and hit the LIKE button and FOLLOW me for more educational
posts and analysis.
Feel free to leave a comment if you have any questions!
I appreciate all the feedback.
Thanks
Trade Safe
