Currency pairs correlation in forex is one aspect of trading most traders do not talk much about. Instead, they prefer to talk about chart patterns, candlestick patterns and other trading systems. However, today we will discuss correlation in detail.
Imagine you have two swings hanging over a beam. If you drag both swings back and let them go at the same time, both swings will move to and fro at the same time and almost at the same speed. At this point, you can say that because both swings are moving in the same direction and at almost the same speed, they are correlated.
What happens when if you drag one swing forward and the other swing backwards, at the same time and let the loose? Of course, both swings will move but in different directions and at almost the same speed. Can you say that they are not correlated because they move in opposite directions? Well, the answer is that there exists a correlation between both swings.
This brings us to the conclusion that correlation is the relationship between two or more things. It could either be positively correlated, or negatively correlated.
In context currency correlation in forex is a positive or negative relationship between two separate currency pairs. A positive correlation means that two currency pairs move in the same direction. For example, if AUDUSD is positively correlated with GBPUSD, this means that if AUDUSD appreciates, so will GBPUSD appreciate as well. On the other hand, a negative correlation means that they move in opposite directions.
An accurate Forex correlation table is a tool every Forex trader needs. It does not matter if you are a fundamental trader, a technical trader or both a fundamental and technical trader. As a currency pair trader, you need an accurate Forex correlation table to properly manage risk.
Why Are Forex Correlations Important?
Forex market correlations are important for traders because they show how various currency pairs move in relation to each other and can inform traders on how best to approach the market.
One of the importance of Forex market correlation is that it helps in risk management. Let’s say, you have a BUY/LONG trade setup on AUDUSD and another BUY/LONG trade setup on GBPUSD, if you decide to take both trades then you will be doubling your risk.
Because both currency pairs are positively correlated, if one trade setup goes against you, automatically the other trade setup will go against you. You will be losing twice as much.
With the knowledge of forex correlations, you can adjust your risk either by splitting your risk into both pairs or taking a single trade setup.
Speaking of splitting your risk, forex market correlation can inform you on how best to diversify your investments or trade. Knowing which currency pairs are positively correlated and which move in opposite directions (negative correlation) can decide what amount and what currency pair to trade and what currency pairs to avoid trading.
Now that we have discussed the importance of Forex market correlations, let us take a look at how we can control our risk using a correlation table.
What is a Forex Correlation Table?
A Forex correlation table serves one purpose which is to show you, at a glance, the various currency correlation pairs. It can be made up of roles and columns. It can also be called a forex correlation matrix. A typical example can be found on Myforexbook. Their correlation table looks like this
A forex correlation table makes currency correlation analysis a lot easier and fun to help traders identify currency pairs that are positively correlated, negatively correlated or not correlated at all.
There are other forex correlation tables out there some of which include
FxBlue, etc.
How to use currency correlation in forex trading
Let’s take a look at a screenshot from the Myfxbook currency correlation calculator. From the screenshot below, we can see that NZDCHF and AUDCAD have a positive correlation of 88.8% as of when this screenshot was taken.
This implies that these two pairs move in tandem (or close to it). This is because their economies share much in common, among other things. The fact that the correlation percentage is 88.8% does not imply that both currency pairs must move “pip for pip”.
To use this information, means that if there is a fundamental or technical analysis that suggests a bearish move on AUDCAD, it will be in your best interest to sell or NZDCHF or close any buy positions you have opened on NZDCHF.
On the other hand, NZDCHF and EURAUD have a negative correlation of 84.5%. This means if NZDCHF goes up, then EURAUD goes down. You do not want to be caught in the market without making use of this correlation tool.
Notes:
One thing to keep in mind when it comes to Forex correlations, is that they do change over time. So while the NZDCHF and EURAUD have a negative correlation of 84.5% today, overtime the market can adjust and both currency pairs will not be as negatively correlated as it is today.
Additionally, two currency pairs can appear to be positively correlated on a daily timeframe, but when the time frame is changed they may not be correlated at all. All the examples, provided above are correlated based on a daily timeframe. Here’s a snapshot of the correlation between AUDUSD and NZDUSD across four-time frames
5 Minute: -39.2% (Negatively correlated)
1 Hour: 14.3% (Not correlated)
Daily: 85% (Strongly correlated)
Weekly: 19% (Not correlated)
You can see how these currency pairs are correlated differently and with different strengths in various time frames.
Similar to other aspects of trading, it’s important to do the research and experiment with various Forex trading analysis tools especially as it concerns correlation currency pairs.
Conclusion
Forex market correlation is important to consider when trading the forex market. It can help out in your Forex trading strategies, helping you make informed decisions, manage your risk in trading and help grow your portfolio as a trader.
Feel free to explore various Forex correlation tools online and check out other interesting blog posts here to help your trading journey.
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