All the financial instruments, including currencies move based on certain behavioral patterns, which may differ from one to another. This article will shed some light on Forex correlation and the extent to which currencies are related.
Currencies are always quoted in pairs, one currency value against another. The price of the British Pound against the US Dollar, the Swiss Franc against the British Pound, the Canadian Dollar against the US Dollar and so on. Even from this set of three currency pairs, you can see that some individual currencies appear more than once.
This means that no single currency pair ever trades independently from others, they are all interlinked. This is called positive or negative correlation – positive when the pairs react in line and negative when they react opposite.
Video: How Market Conditions Affect Currency Pairs
Positive Correlation -Three of the most traded pairs in the Forex market -GBP/USD, AUD/USD, and EUR/USD are positively correlated with each other, as the counter currency is the US dollar. Therefore any change in the strength of the US dollar directly impacts the pair as a whole. Moreover, the pair NZD/USD also called ‘Kiwi’ is also positively correlated to the above mentioned major pairs.
Negative Correlation – Non-correlated currency pairs to these majors include USD/CHF, USD/JPY, and USD/CAD. You must have noticed that the base currency in these pairs is the US dollar and that is the reason why they move in the opposite direction of the above-mentioned majors where the USD is the counter currency.
Currency Pair Correlation Table
If you were trading the British Pound vs. the US Dollar you will also be partly trading the Euro vs. the British Pound. It stands to be true then that the British Pound vs. US Dollar trade must be correlated in some way to the Euro vs. the British Pound. Knowing which pairs move opposite and which move together is a useful tool for a trader, but can be hard to work out, particularly due to the fact that correlation in Forex can change.
Market sentiment and different economic factors are fluid and can change daily leading to swings in correlations between currency pairs. A strong positive correlation may turn out to be a negative correlation; equally, a correlation on the same pair could be different depending on the time frame of the trade you are looking at. A common Forex currency correlation strategy that forecasters and traders employ is the 6-month correlation, but these can be different to the Forex correlation on your hourly chart.
What to Do with Your New Forex Correlation Understanding?
Money management is the biggest tool in your Forex trading toolbox, correlation in Forex and money management can go hand in hand. If you trade across multiple currency pairs frequently, then you must be aware of correlations. If you are long on one currency pair and short on another, it could be that this trade is actually canceling itself out because they are both correlated the same way. Equally, if you are long and short on different pairs then you could be over leveraged on one currency pair without even realizing.
Try and spot these changes in your trading account, it is the only way to get familiar with it. It all comes down to exposure. Your understanding of correlation between currency pairs will help you keep your exposure to a level that your trading strategy and you are comfortable with.
Remember, in trading, it doesn’t matter how well a single trade does. Your goal is to not prove every trade correct; it is to manage your account and grow your account. You will find that easier to do once you are aware of your total exposure in the markets.