In this article, you will discover the easiest way to use currency correlations to your advantage. Rather than give you the math, this article gives you the secrets, the short-cuts, and even tells you which currencies to watch.
Currency correlations, or patterns, are often more predictable, albeit less profitable, when dealing with the most traded currencies. Maybe this is because there are more trades going on at any one time with the most traded currencies, or perhaps it is because there are so many people using Currency Correlations that it actually becomes a self-fulfilling prophecy.
How Does Something Like Currency Correlations Become a Self-Fulfilling Prophecy
Let’s say that there is an urban legend that says whenever Microsoft share prices go down, Apple share prices will go up. Then, one day, Microsoft shares start to dip a little, so lots of people rush out and buy Apple shares. Suddenly Apple shares shoot upwards (aka, a self-fulfilling prophecy).
By the same token, currency correlations could be self-fulfilling prophecies if there was a widespread belief that if the Baht goes up, then the Euro goes down. Therefore, when the Baht goes up, people sell their Euros, making them go down in price.
Currency Correlations in Their Simplest Terms
The most common cause of currency correlations happens because no currency is ever able to change on its own. A share price may rise and fall independently, but currency traders are always linked. For example, you turn USD to AUD. You cannot just sell your USD, you have to swap them for another currency.
Currencies have to be traded in pairs. They are linked. When pairs react in line, this is called a positive correlation. When they react opposite, this is called a negative correlation.
Tips on Using Currency Correlation
Firstly, remember that coefficients are calculated using closing prices. A negative coefficient indicates that two currencies will move in opposite directions. Positive coefficients mean the currencies will generally move in the same direction.
Learning how to understand the correlation ratios is not that difficult. The numbers you see represent how strong or negative the correlations are and how positive or negative they are. Remember that a negative move in opposite directions and a positive move in the same direction.
So if two currencies have a strong positive currency coefficient, then they will both rise and fall at pretty much the same time. If a currency coefficient is at or near +1 or -1, then the two currency pairs are pretty highly related.
FOREX correlations percentages are just the numbers -1.0 and +1.0 in percentages, there is nothing more to it. But, rather than muddy the water with things like correlation pair list with percentages, here is a list of currency pairs that most often move in the opposite direction. There is little point in learning why the best correlations pairs do what they do if this article can simply show you the most correlated pairs.
This is the list of Most correlated pairs.
- USD/CHF and EUR/USD
- USD/CHF and GBP/USD
- AUD/USD and USD/CAD
- USD/JPY and GBP/USD
- AUD/USD and USD/JPY
Here are the pairs that you will find often move in the same direction. Again, why bother giving you pointless formulas and percentages on correlations when we can just give you the answers showing positive correlation coefficients.
This is the list of correlated pair moving in the same direction
- USD/JPY and USD/CHF
- GBP/USD and EUR/USD
- NZD/USD and EUR/USD
- AUD/USD and EUR/USD
- NZD/USD and AUD/USD
The Effectively Use of Currency Correlations
All you need to do is use the correlations listed above and make trades based on how they move. Take the first list. If you see prices going in one direction for those on the left, then start trading knowing that the ones on the right will go the opposite direction.
It is really that simple. Take the second list. If you see those in the left column go up or down, then bet on the corresponding ones on the right to go up or down in the same way. It is easy!
But What About All Those Large And Complex Formulas?
If you have looked online for other articles on things like a hedge trading, coverage ratio and a correlated strategy, you will have seen articles with complex equations. You are probably asking, “Don’t I need them too?”
As the popular philosopher, Nassim Taleb may say, “Complex formulas are what we wrap ourselves in for comfort.” In other words, creating complex formulas to guess things like changes on FOREX pairs and where to find correlated pairs is fruitless.
It is no better than guessing, but the use of complex formulas makes us feel better about our guesses.
Just like the stock market, you can make observations, and after a while, you will see patterns. For example, we all that that there will be at least one health scare per year. It is often a good idea to diversify with a few pharmaceuticals companies every year when you are picking your stocks.
The Brexit event, and the way President Trump has reignited the US economy has been great for people trading in GPB and USD. In fact, if you were keeping a lookout for positive and negative correlated currency pairs.
Then you would have noticed patterns involving the USD and GPD that both correlated with AUD/USD and EUR/USD, and that correlated with breaking news stories. It was a great time to be a FOREX currency trader.
If you are going to trade correlated currencies, then you do not need to wait for national and global events. Hitting your foreign exchange and making lots of cash “because” of global events is fun, but correlation trading is always there for work-a-day traders who want to make modest profits.
You can make trading correlated pairs your everyday job, while always being vigilant for global news stories and new currency correlations.
For example, India has leapfrogged the UK and France to become the fifth-largest economy in the world. This is going to have a ripple effect on global currency prices for years to come. It is worth keeping an eye out for new trends and currency correlations relating to Asia.