Forex is a huge worldwide network in which all financial instruments are interconnected with each other. It’s not a secret that some assets can influence others. This match is known as Currency Correlations and is an essential indicator in market analysis. Using it, a trader can significantly reduce the possibility of failures and increase income by trading several currencies at the same time. Dive into the topic and become a pro with this article!
1. What Are Currency Correlations?
Correlation is a mathematical term. It is a measure that indicates how variables fluctuate in relation to each other. Its value signifies the strength of the interconnection. It often happens that the chart of one pair is very similar or almost identical to the chart of another pair. Or oppositely: these charts are, to one degree or another, mirror images of each other. In the first case, we are dealing with a direct modification, and in the second — with an inverse one.
2. Types of Currency Correlations
As mentioned above, two varieties can be identified. Positive is also known as “direct,” while negative is called “inverse.” How do they differ, and what are their meanings?
- Positive: charts are identical or similar to each other. All patterns are most probably the same. This can often be seen in the EUR/USD and GBP/USD. Obviously, this kind of correlation can confirm your forecasts and give you a certain level of flexibility.
- Negative: price movements change in different trajectories. That is to say, the trend of one instrument mirrors the chart of the second instrument. Often, such a type is demonstrated by USD/JPY and EUR/USD.
3. Using Currency Correlations in Forex Trading
To use the indicator of interdependence, it must first be calculated. Obviously, it is a relative value, which is measured as a percentage. 100% means the graphs are absolutely identical. For calculation, you can use the Pearson formula or the tabular method. In the second case, you can easily compute the value in MS Excel by loading tabular data of two pairs on the desired time range. In addition, there are indicators that provide ready-made calculations. A Forex robot can also use and display all this data.
Knowing this indicator, you can use it as a trend confirmation. If, for example, you predict a trend change on the first pair using chart patterns, the same change is likely to occur with the second pair. You can diversify your risks by buying or selling two different assets. A Forex correlation strategy is useful in hedging and risk balancing as well.
4. Monitoring and Adapting to Currency Correlations
Forex correlation trading is quite simple. The basic principle is as follows: choose a pair to deal with and keep a close eye on other pairs that correlate with it. The interdependence of the movement of pairs changes periodically. This means that you need to calculate the values at regular intervals. Such changes are due to the fact that new events occur daily in the economy and politics, and the market reacts. If you have long-term charts for 3 or 6 months, it is advisable to update the data about once a week.
The best way to quickly adapt to changes is to use specialized digital tools to track and analyze mutual changes. Thus, you can quickly adjust your strategies (in terms of volumes, leverages, time ranges, etc.) and better understand the risks. By the way, what does Forex leverage mean? It is a coefficient that shows how much borrowed funds an FX active participant use.
The Forex pairs correlation is an invaluable tool that, when used correctly and thoughtfully, gives the trader the opportunity to increase the profitability of transactions. Correlation coefficients are useful for traders who trade several currency pairs simultaneously. They confirm the trend and help diversify risks. However, the market is in constant motion, so it is necessary to constantly monitor the situation and adapt to changes. If you master this indicator, you will surely be able to improve your trading results.