Currency Correlation Trading

Currency market is a highly interlinked market with many currency pairs showing positive or negative correlations with each other. These correlations means that these currency pairs don’t move independently of each other. If you trade two currency pairs that are highly correlated, you might increase your risk without knowing it.

Now, trading with more than one currency pairs requires a knowledge of these correlations. You might be thinking of diversifying your portfolio whereas in reality you might be doubling your position by trading two highly correlated currency pairs.

Let’s take an example. USDJPY and USDCHF may be showing a high positive correlation in the last month. This high positive correlation something like +0.86 means both are moving in the same direction.

When you trade both these pairs together, you might double your risk unintentionally. In the same manner, it might also not be a good idea to good long on one and short on another because rally in one pair will most likely set a rally in the other pair as well.

In the same manner, two currency pairs can show a negative correlation. Negative correlation means that both move in opposite direction most of the time. If one moves up, the other will move down. Suppose you are trading EURUSD and USDCHF and both have a negative correlation coefficient of -0.84. This means both of them move in opposite direction.

So, going long on one and short on another will only double your position. In the same manner, going long or short on both at the same time will also be not good as it might end up with zero profit or almost zero profit.

The important thing for you to understand is that these correlation coefficients keep on changing with time. So, if two pairs are showing a strong correlation, they might not show such a strong correlations a few months down the road.

This is due to the fact that the market conditions keep on changing plus market sentiment also changes over time. So, these correlation coefficients between different currency pairs are not going to be the same every month.

Always use the knowledge of correlations when trading more than one currency pair at the same time. Get this highly profitable Magic Breakout Forex Strategy by Tim Trush and Julie Lavrin FREE. Get these Correlation Trading Cheatsheets FREE.

1 Comment

  • trade4target

    May 18, 2011

    Good Stuff ! I really like your post and i definitely bookmark your post and will give links to my friends as we all are a great lovers of blogs and always ready to read interesting and informative blogs. So Thanks ! for sharing your post.
    Regards:
    Trade4target