All the financial instruments, including currencies move based on certain behavioral patterns, which may differ from one to another. This article will shed some light on Forex correlation and the extent to which currencies are related. Currencies are always quoted in pairs, one currency value against another. Even from this set of three currency pairs, you can see that some individual currencies appear more than once.
This means that no single currency pair ever trades independently from others, they are all interlinked. This is called positive or negative correlation — positive when the pairs react in line and negative when they react opposite.
Therefore any change in the strength of the US dollar directly impacts the pair as a whole. You must have noticed that the base currency in these pairs is the US dollar and that is the reason why they move in the opposite direction of the above-mentioned majors where the USD is the counter currency. If you were trading the British Pound vs.
It stands to be true then that the British Pound vs. US Dollar trade must be correlated in some way to the Euro vs. Knowing which pairs move opposite and which move together is a useful tool for a trader, but can be hard to work out, particularly due to the fact that correlation in Forex can change.
Market sentiment and different economic factors are fluid and can change daily leading to swings in correlations between currency pairs. A strong positive correlation may turn out to be a negative correlation; equally, a correlation on the same pair could be different depending on the time frame of the trade you are looking at.
A common Forex currency correlation strategy that forecasters and traders employ is the 6-month correlation, but these can be different to the Forex correlation on your hourly chart. Money management is the biggest tool in your Forex trading toolbox, correlation in Forex and money management can go hand in hand.
If you trade across multiple currency pairs frequently, then you must be aware of correlations. If you are long on one currency pair and short on another, it could be that this trade is actually canceling itself out because they are both correlated the same way.
Equally, if you are long and short on different pairs then you could be over leveraged on one currency pair without even realizing. Try and spot these changes in your trading account, it is the only way to get familiar with it.
It all comes down to exposure. Your understanding of correlation between currency pairs will help you keep your exposure to a level that your trading strategy and you are comfortable with. Your goal is to not prove every trade correct; it is to manage your account and grow your account. You will find that easier to do once you are aware of your total exposure in the markets.
Understanding how currency correlation works and what market factors affect different currency pairs is crucial in forex trading. Zero in on Profits with the Momentum Breakout Strategy. You must be logged in to post a comment. Contact Us Search Login. By Market Traders Institute. About Market Traders Institute. Leave a reply Click here to cancel the reply You must be logged in to post a comment.More...