Educational: Balancing your watchlist
Let's imagine it is Sunday, and you're preparing your watchlist for the week.
You use the market scanner to create your watchlist. You can learn about the market scanner here:
đź“ŠYour list contains:
EURUSD 
GBPJPY GBPUSD 
NZDJPY 
XAUUSD USDJPY
It's now Monday, and you start to trade. At the end of the week, you check your results and you have about a 50% win rate. For every win that you got, you experienced a loss, and your trades were very close in time to each other. What has likely happened here is that you did not balance your watchlist before the start of the trading week.
đź“ŠWhat is correlation :
In trading, pair correlation refers to the statistical measure of the relationship or association between two or more financial instruments, typically stocks or other securities. It quantifies how the prices of these instruments move in relation to each other over a given period.
Pair correlation analysis helps traders and investors identify and exploit potential trading opportunities. By studying the historical price movements of two instruments, traders can gain insights into their relationship and make informed decisions.
The pair correlation coefficient is a common measure used to assess the degree of correlation between two instruments. It ranges from -1 to +1. A correlation coefficient of +1 indicates a perfect positive correlation, meaning that the prices of the two instruments move in the same direction. Conversely, a correlation coefficient of -1 indicates a perfect negative correlation, where the prices move in opposite directions. A correlation coefficient of 0 signifies no correlation, indicating that the prices of the two instruments are unrelated. (note that some programs might use a different scale to determine correlation but these are industry standards)
đź“ŠHow it affected your trades:
If you are experiencing a phenomenon where your setups/trades are being triggered around the same time, and it often happens that one trade runs in profit while the other does not, you are likely experiencing a negative correlation between the pairs in your watchlist.
If you are opening buy positions on two pairs, but one is negatively correlated with the other, you are very likely to experience a loss in one of those trades.
As we can see in the image, if you had entered a buy position on both pairs, one would end up being a losing position due to the negative correlation.
đź“ŠHow to combat this issue:
🔹When creating your watchlist, it is a good idea to note the correlation between all the pairs and create a subsection marked for negative and positive correlation. This way, if you get a buy signal on two pairs that are currently negatively correlated, you can determine which signal has a higher chance of being accurate and execute the trade only on that pair. Usually, the pair with the most confluence for the buy or sell position has a higher chance of being correct.
🔹Execute trades with a risk-to-reward ratio of more than 1:1. This way, even if you execute both trades and one goes against you, you can still make a profit overall. Please refer to the diagram below.
đź“ŠHow to check pair asset correlation:
There are several ways to check the correlation between assets. I won't recommend any specific third-party websites here, but you can search for "forex correlation" on a search engine to find various websites that offer this feature. Alternatively, you can search for an indicator on TradingView that provides correlation analysis.
One being, Script by :LeviathanCapital https://www.tradingview.com/script/uy1LMmRg-Correlation-Matrix-Heatmap-By-Leviathan/
You use the market scanner to create your watchlist. You can learn about the market scanner here:
đź“ŠYour list contains:
EURUSD GBPJPY GBPUSD NZDJPY XAUUSD USDJPYIt's now Monday, and you start to trade. At the end of the week, you check your results and you have about a 50% win rate. For every win that you got, you experienced a loss, and your trades were very close in time to each other. What has likely happened here is that you did not balance your watchlist before the start of the trading week.
đź“ŠWhat is correlation :
In trading, pair correlation refers to the statistical measure of the relationship or association between two or more financial instruments, typically stocks or other securities. It quantifies how the prices of these instruments move in relation to each other over a given period.
Pair correlation analysis helps traders and investors identify and exploit potential trading opportunities. By studying the historical price movements of two instruments, traders can gain insights into their relationship and make informed decisions.
The pair correlation coefficient is a common measure used to assess the degree of correlation between two instruments. It ranges from -1 to +1. A correlation coefficient of +1 indicates a perfect positive correlation, meaning that the prices of the two instruments move in the same direction. Conversely, a correlation coefficient of -1 indicates a perfect negative correlation, where the prices move in opposite directions. A correlation coefficient of 0 signifies no correlation, indicating that the prices of the two instruments are unrelated. (note that some programs might use a different scale to determine correlation but these are industry standards)
đź“ŠHow it affected your trades:
If you are experiencing a phenomenon where your setups/trades are being triggered around the same time, and it often happens that one trade runs in profit while the other does not, you are likely experiencing a negative correlation between the pairs in your watchlist.
If you are opening buy positions on two pairs, but one is negatively correlated with the other, you are very likely to experience a loss in one of those trades.
đź“ŠHow to combat this issue:
🔹When creating your watchlist, it is a good idea to note the correlation between all the pairs and create a subsection marked for negative and positive correlation. This way, if you get a buy signal on two pairs that are currently negatively correlated, you can determine which signal has a higher chance of being accurate and execute the trade only on that pair. Usually, the pair with the most confluence for the buy or sell position has a higher chance of being correct.
🔹Execute trades with a risk-to-reward ratio of more than 1:1. This way, even if you execute both trades and one goes against you, you can still make a profit overall. Please refer to the diagram below.
đź“ŠHow to check pair asset correlation:
There are several ways to check the correlation between assets. I won't recommend any specific third-party websites here, but you can search for "forex correlation" on a search engine to find various websites that offer this feature. Alternatively, you can search for an indicator on TradingView that provides correlation analysis.
One being, Script by :LeviathanCapital https://www.tradingview.com/script/uy1LMmRg-Correlation-Matrix-Heatmap-By-Leviathan/
C Nicholas Downie
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