
Hi, traders. Let’s continue talking about trader’s checklist. The beginning is here. In other words, there are some important observations that trader has to take into consideration. Too much analysis is harmful, but analysis is harmful as well – in this case, trader loses sense of big picture and will end up blindly following the price.
6. Is there any correlation between trading instruments?
Markets are traded on its own most of the time, but sometimes there are cases when market is driven by a single idea – for example, weakening US dollar or «flight-to-safety» (when market reevaluates risk and traders move funds from «risky» assets to «less risky»).
Correlation analysis can give you the clue – is there any financial instrument that goes against major fundamental tendency? If you capture one, you can sometimes find good opportunity that could not be identified with any other type of analysis.
There are several major «groups» within currency market that can help us.
European currencies: EURUSD, USDCHF (chart should be upended), EURGBP and other EURUSD crosses. GBPUSD is standing alone from this group, but sometimes it correlates with EURUSD.
Commodity currencies: AUDUSD, USDCAD (chart should be upended). AUDUSD often (but not all the time) correlates with gold - XAUUSD
There can be a correlation between currencies in a group, you may spot some opportunities, when one instrument underperforms. They key here is to identify «leading» instrument and «laggard». It’s not an easy task though.
According to my opinion, it is much easier to spot situations when the whole market is accumulating (or distributing) US dollar, but one instrument, say, goes in the opposite direction. It’s impossible for any market participants to fight fundamental factors.
For example, look at the picture below:
correlation.png
Do you see anything unusual here? Of course, USDCAD is weakening against US dollar, it’s obvious. Other pairs are gaining against US dollar, so there might be something wrong building on USCAD. And, it was a good opportunity to sell USDCAD, it was one of the most profitable swing trades that I have made on my account.
I don’t care why USDCAD is moving against the market – I just see it and act upon this anomaly. Reasons for that may lay outside of traditional market logic. For example, sometimes market is manipulated in a short-term perspective to hold the price above or below some levels to let large option or forward contracts expire worthless. We will not talk about this now, it just happens.
But I have to warn you not to play the «correlation game». It occurs when trader automatically thinks that one instrument automatically goes after another and acts in an impulsive manner. It ends up poorly.
So, as you see, keeping an eye on correlations sometimes can be very beneficial and helpful. Of course, good setups are quite rare, but if you have a tool that can help you find good trading idea, why not to use it?
to be continued…