Currency correlation is a statistical measurement of a relationship between two major trading assets. The currency correlation is usually shown to the extent which the currency pairs in question have moved on different, random or the same directions within a certain specified period. Analyzing the relationship between two assets using the past empirical data helps potential investors to identify the available trading opportunities and manage their degree of risk exposure.
- When +1 correlation indicate that two trading currency pairs are moving in the same direction that is considered to be a positive correlation.
- Where the -1 correlation indicates that two trading pairs are moving in the opposite direction, that’s termed as the perfect negative correlation.
- A zero correlation takes place when the relationship between the paired currencies comes in randomly without any linking.
Basically, the stronger the negative or positive the correlation is, the more the trader draws stronger correlation foam the analysis. The long periods are used to show more accurate information on the technical report.
Currency correlations change
Beware that the currency correlations do not always remain in the same place due to the changing political and economic factors. The common economic factors which affect the correlations are commodity prices, changes in monetary policies and the central bank policies. A strong correlation is therefore subject to change.
Calculating correlations yourself
Forex traders can maintain the current strength and direction of their correlation pairings by calculating them. This may sound quite difficult for beginner investors, but the process is straightforward.
You can calculate the simple currency correlation by using a spreadsheet program such as Microsoft Excel. The program allows you to download the daily currency prices, and then complete it with correlation function.
Currency correlation trading tips
As mentioned, the correlation often changes as so you must have the right strategies to apply in each phase. Consider these tips:
- Avoid the positions which cancel each other– when you keep seeing two currency pairs moving into the opposite directions every time, try to avoid that as holding those long positions for a longer time might mitigate your potential gain.
- Diversify with minimal risks when you invest in different pairs with a positive correlation, one of them will mitigate the risks while the other will maintain a positive direction.
- Hedge exposure– you can minimize your losses by hedging against any two trading pairs which have a perfect negative correlation. The reason behind this is that the value of one product will increase if you hold the ones which are currently losing their values.
- Start trading with a demo account– if you have just learned about the currency correlation; use a demo account to test your skills before you join the live market. Open ten positions at once and then split your portfolio into different categories.
What you can do with your currency correlation knowledge
Money management is among the top forex trading tools, and the correlation goes hand in hand with the management of Exchange Traded Funds. When you frequently carry out your forex trades with several currencies pairs, you must be conversant with currency correlations. If you go long on a single currency and go short on another, this could be signaling that your trades are canceling each other merely because they are moving in the same direction. In the same way, if you go long on a particular currency and short on another pair, then one of the pairs might be having higher leverage without the other without your knowledge.
Currency correlations help you to spot and do the necessary follow-ups on these changes. The correlation understanding will also assist you to gain exposure at the trading strategies that you are comfortable with. Remember, forex trading does not crucial in how a particular single trade performs, as your primary goals are not to [prove the trades which are correct but to gain maximum profit. Your forex market exposure will give make trading easy to you.
