Currency correlations

1. ## Currency correlations

What is currency correlation and how do traders use them?

Choosing the strategy for trading in the Forex market one needs to remember that not a single currency pair is isolated. In many cases, the economic situation abroad, interest rates, fluctuations in commodity prices affect more than one currency pair. Everything is interconnected in the currency market to a certain extent, and knowing the direction and extent of the relationship between some pairs a trader can use this to his advantage. The ratio between the currencies can be a very useful tool of trading.

If you're going to operate more than one pair, then you must consider the movement of one currency relative to another one in order to increase profits. We use an analysis of correlations for this purpose. Correlations between currencies are calculated on the basis of exchange rates, and with these figures we can determine the relationship between the pairs. These data will help the trader to diversify his portfolio, double position without additional investment in the same pair or simply estimate the risk of currency transactions. When used properly, this method will help maximize profits, estimate risk and protect from unproductive, unprofitable trade.

2. Positive and negative correlations, what they mean and how to use them

Calculation of correlations between currency pairs in your portfolio is a great way to evaluate the investment risk. Investing in different pairs, you might think that you diversify your portfolio, but in fact many of them can change in parallel or opposite directions.

Currency correlations can be both strong and weak, and can last for weeks, months and even years. The size of the correlation shows how close or how opposite the courses of two pairs were moving during a certain period. The correlation value is represented in decimal form, and the closer it is to 1, the stronger the correlation.

For example, the correlation between EUR / USD and NZD / USD is equal to +0.94. If it is inconvenient for you to use decimals, you can use the percentage by multiplying the number by 100 (in this case, the correlation between EUR / USD and NZD / USD is equal to 94%). A high correlation means that currency pairsâ€™ courses change more or less synchronously. Low correlation suggests that the courses vary in different ways.

3. Therefore, the high correlation between EUR/USD and NZD/USD indicates that investments in these pairs lead to the doubling of positions. Also, you do not need to open a long position on one pair and short on the other, as the growth rate of the first pair can trigger the growth of the second one. Ultimately, the amount of your profit and loss will not be zero, because the courses of both pairs in terms of pips are different. But they move so similarly that opening opposite positions may reduce profit or even lead to a loss.

Movement of currency pairs can be estimated not only by the positive correlation, negative correlation can also be very useful. As with the positive correlation, the closer the number to -1, the more fluctuations of two pairs are related, but this time they vary in opposite directions.

Letâ€™s take EUR/USD as an example. There is a strong positive correlation between NZD/USD and EUR/USD and at the same time EUR/USD has a strong negative correlation with the USD/CHF, which is -0.98 per year, and -0.99 per month.

These figures show that these pairs have a strong tendency to change in opposite directions. Consequently, the opening of the opposite positions in these pairs is like opening the same positions in pairs with a strong positive correlation, i.e. it means a doubling of the positions, which may also increase the risk of the portfolio. But long or short position for both pairs is likely to be counterproductive and can lead to a near-zero sum of profits and losses, as the courses of the two pairs change in the opposite ways. If one part of a transaction makes a profit, then the other makes a loss.

4. Important: correlations change

Anyone who has ever traded in the Forex know that the currencies are very dynamic. Economic conditions, market sentiment and prices change every day. In this regard, while analyzing the currency correlations you need to remember that it may change over time. Strong correlations today may weaken next month.

If you decide to use this method in trading, then you should keep a track of the interdependence of currencies. For example, the correlation between the USD / CAD and USD / JPY was 0.06 during a month. It is very low, which means that changes in these currency pairs are almost unconnected. But if we look at the rate during three months, weâ€™re going to see that the correlation was higher - 0.12, in the first six months it was 0.59 and for the year - 0.80. Thus, this example shows that in the last month the connection between the two pairs became much weaker. The long strong correlation disappeared in a short time almost completely.

Another example: USD / CHF and AUD / USD. The data shows that the connection between them has recently strengthened. The correlation is -0.78 for the year, and for the last month it was 0.94. This indicates that if the transaction in one pair is profitable, the transaction in the other will likely lead to losses.

Even more significant example of correlation change is in GBP / USD and AUD / USD. According to data for the year, the correlation between them was -0.87, that is their courses in the long run were varying in opposite directions. However, in January-March 2005 the correlation was positive (+0.24). The main reason for changing the degree and direction of currency correlation can be the major economic event, like changes in interest rates.

5. How the correlations are calculated

As the connection between currency pairs usually changes during a certain period, the ideal way to track the direction and degree of correlation is the independent calculating. At first it may seem complicated, but the calculations can be simplified.

The easiest way to do it is to use Microsoft Excel: you enter the currency pairs, which correlation needs to be calculated over a certain period, and then use a special function. The most accurate representation of the currency pairs movement can be given by the data for one year, six months, three months and one month. But you can decide by yourself what indicators and how many of them youâ€™re going to analyze.

The process of calculating the correlation for GBP / USD and USD / CHF will be the following: first you need to pick data on the courses of two pairs. Then arrange them in a table, one column is GBP, the other - CHF, in the cells there are the numbers of week course (use the exchange rate of the last week in relation to the U.S. dollar no matter what time period is considered). At the end of the two columns in the empty cell you enter = CORREL. Then select the data in one column, insert a comma and select the second column. The resulting number is the desired correlation. No need to update the data in the table every day, it is better to do it once every two weeks or at least once a month.

6. In particular, the money taken higher. One reason for this was the In german stock exchange was, temporarily, in freefall. Investors and traders thrown quickly into â€œrun to the hillsâ€ method. It seems sensible for the European to experience in those conditions. It kind of seems sensible for the money to increase. After all, it is still commonly regarded a safe home, or just about.

7. I had one very good strategy made upn the currency co relation. But although i never used it though.
But yes, my friends used it and they made a lot of profits. It was simply trading the negative and positive cor relation . And so within a day you will be in profits .
If i would remember it again , wiill share soon to all of you all :)

8. Originally Posted by Gulfstream
For example, the correlation between EUR / USD and NZD / USD is equal to +0.94. If it is inconvenient for you to use decimals, you can use the percentage by multiplying the number by 100 (in this case, the correlation between EUR / USD and NZD / USD is equal to 94%). A high correlation means that currency pairsâ€™ courses change more or less synchronously. Low correlation suggests that the courses vary in different ways.
Sometimes I see when eur / jpy aud up the / usd go down, and did not have to, but I often see it, whether it's correlation, and perhaps some traders also viewed pairs eur / usd and usd / chf as a form of reversal, and may some traders can take trading with the conclusions in this correlation

9. The best correlated pair in the forex majors is the EUR/USD cor related with USD/CHF.
These are the bestly correlated pairs. One must watch how they move negatively against each other.

10. I am not familiar with the techniques of currency correlations. I've never tried it before. How do action into a technique, whether the currency correlations in meaning are (for example eur/usd and usdchf) when eurusd downtrend and usdchf uptrend and could sell to eurusd and buy for usdchf?