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Currency correlations

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When trading forex, it is vital that we are aware of something called currency correlation. This is the relationship between two or more currency pairs, and how when one pair moves it usually signifies a move in the other currency pair.

However, it does NOT always mean that the correlated currency pair will move in the same direction.

We have three types of currency correction, these are:

Perfect positive currency correlation

This signifies that every time the currency pair moves, the second pair will move in the SAME direction 100% of the time.

Perfect negative currency correlation

This signifies that every time the currency pair moves, the second pair will move in the OPPOSITE direction 100% of the time.

Zero currency correlation

This signifies that there is NO correlation between the two currency pairs and that the movements between them are totally random.

What does this mean for our trading?

  • More knowledge means that we have a higher likelihood of being able to develop more profitable trading strategies as a result.
  • In Forex, it is entirely plausible to trade positions that effectively cancel each other out. If two currency pairs have a negative correlation with one another, then their moves will directly counteract one another, and it will leave you at a loss.
  • Can be used to show how much risk we are exposed to. If we have several currency pairs trading at the same time and they all have high positive correlations, then we will be overexposed and often doubling or even tripling our risk.
  • You can effectively hedge and manage your existing positions.

Currency Pairs that typically have a positive correlation (SAME direction)

  • EUR/USD and GBP/USD
  • EUR/USD and AUD/USD
  • USD/CHF and USD/JPY

Currency Pairs that typically have a negative correlation (OPPOSITE direction)

  • EUR/USD and USD/CHF
  • GBP/USD and USD/JPY
  • GBP/USD and USD/CHF

NOTE: Currency correlations change. Do not take these for gospel. It’s important to be vigilant when trading, never assume that these numbers will remain the same forever.

Correlated Commodities

One important thing to bear in mind is how certain currencies can be heavily correlated with commodities.

Some country’s economies rely heavily on exports of a certain commodity, so if they particular industry takes a hit then you can pretty safely assume that the currency will follow in the same direction, and vice versa.

Two famous examples of this are:

  • AUD and Gold
  • CAD and Crude Oil

Knowing which currency is tied with what commodity can give traders an advantage and can help you understand why the market moves the way that it does.

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