Understanding currency correlation

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What is currency correlation?

The interdependence among currencies stems from more than the simple fact that they are in pairs. While some currency pairs will move in tandem, other currency pairs may move in opposite directions, which is in essence the result of more complex forces.

The correlation coefficient highlights the similarity of the movements between two parities.

It is a number ranging from -100 to +100.
A correlation of +100 implies that the two currency pairs will move in the same direction 100% of the time. A correlation of -100 implies the two currency pairs will move in the opposite direction 100% of the time. A correlation of zero implies that the relationship between the currency pairs is completely random.

Regardless of your trading strategy, it is very important to keep in mind the correlation between various currency pairs and their shifting trends.

If the correlation is high (> 80) and positive then the currencies move in the same way.

If the correlation is high (> 80) and negative then the currencies move in the opposite way.

If the correlation is low (< 60) then the currencies don’t move in the same way.

The correlation index are calculated on the daily and hourly data. Thanks to the tools offered by Mataf.net, you will be able also to calculate the correlation of a pair compared to a basket of currencies and to study more precisely the correlation between two parities.

Examples of same direction moving currency pairs are:

EUR/USD and GBP/USD
EUR/USD and NZD/USD
USD/CHF and USD/JPY
AUD/USD and GBP/USD
AUD/USD and EUR/USD

Typical inversely moving pairs are:

EUR/USD and USD/CHF
GBP/USD and USD/JPY
GBP/USD and USD/CHF
AUD/USD and USD/CAD
AUD/USD and USD/JPY

How to use currency correlation in your everyday trading

1. Avoid trades that cancel each other.
   For example, EUR/USD and USD/CHF have got a very high inverse correlation (< 90). There would be no point to go short or long on both.
2. Use this information to open “backup trades”.
   If you are long on EUR/USD and the pair is trying to invert the trend, you may want to open a small long position on USD/CHF to tamper small losses.
3. Diversify risks in trades.
   Choose two pairs that move with a correlation coefficient of about ±70. They don’t move the same, but they’re still quite linked together. Splitting the orders will preserve trader’s positions from sudden “jumps” in price and as these currencies move not 100% identical a trader will have some time to react adequately.