Posts Tagged ‘currency correlation’
Applying Currency Correlation When Trading Forex
October 14th, 2009
Using Correlations In Currency Trading
When you first start in forex trading, you will soon realize that some currency pairs seem to move in a similar pattern while others move in opposite directions. Understanding and using this relationship between currency pairs is crucial to your long term market trading success. Many traders are simply unaware of these relationships, and wonder why their trading positions remain static or largely negative when they have several open positions. The reason is simple, it’s called currency correlation.
Currencies can be correlated either positively or negatively. If two pairs are perfectly correlated in a postive way they will have a correlation factor of 1. When they are correlated in an inverse relationship, then their correlation factor would be -1. For example if two data sets are directly correlated, then as one data set moves by one unit, then the other will move in the same direction by the same amount. In the case of a negative correlation, when one data set moves down by one the other data set will also move down by one. The closer data sets are to the factor being either one, postive or negative the closer they are correlated.
I do not propose to explain the maths of calculating the values, but it is important when trading, to understand these relationships between currencies. I is also important to appreciate that whilst two pairs may relate to one another over a period of a few hours or days, this does not necessarily mean that this will continue for weeks or months. Various factors may affect this relationship where the correlation value falls or becomes meaningless. As a rule of thumb, if this is below 0.85, then the relationship has less meaning.
How To Use It To Manage Exposure
Now that you know how to calculate correlations, it is time to go over how to use them to your advantage.
First, they can help you avoid entering two positions that cancel each other out, For instance, by knowing that EUR/USD and USD/CHF move in opposite directions nearly 100% of time, you would see that having a portfolio of long EUR/USD and long USD/CHF is the same as having virtually no position – this is true because, as the correlation indicates, when the EUR/USD rallies, USD/CHF will undergo a selloff. On the other hand, holding a long postion GBP/USD and EUR/USD is similar to doubling up on the same position since the correlation is so strong.
Using Currency Correlations to Hedge Your Position
If a pair correlates perfectly and is a direct relationship then buying one and selling the other will work as a hedge. For example, suppose we think the EUR/USD is going up, this implies that the USD/CHF is going down. If we bought 5 contracts of the first pair and sold 5 contracts of the second, if they were in perfect inverse correlation, our balance would stay much the same. In order to make money, we could therefore decide to weight our decision, but still use a hedge. By buying 5 contracts of the first pair as before, but only selling 3 of the second, we still have a hedge if it all goes wrong, but we have weighted our decision by 2 contracts on the EUR/USD going up. Using your correlations with hedging is a powerful way to spread and manage the risk in your currency trading.
Forex Correlation Code Platform
While this is a powerful tool to improve your trading bottom line. Wouldn’t it be great if their were a way to automate this whole proccess. Well now there is and it is called the Forex Correlation Code.
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Forex Correlation Code Platform
While this is a powerful tool to improve your trading bottom line. Wouldn’t it be great if their were a way to automate this whole proccess. Well now there is and it is called the Forex Correlation Code.
Other sites talking about Forex currency correlation.
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An Introduction to Currency Correlation
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