Understanding Forex Correlation 📈📉Hello Traders! 😃 In this education idea, we are going to cover Forex Correlation and how you can use this information to help you make wise decisions in the market. Let's get started on this important topic...
What is Currency Correlation?
A currency correlation in forex is a positive or negative relationship between two separate currency pairs. A positive correlation means that two currency pairs move in tandem, and a negative correlation means that they move in opposite directions. Correlations can provide opportunities to realize a greater profit, or they can be used to hedge your forex positions and exposure to risk. If you can be certain that one currency pair will move alongside or against another, then you can either open another position to maximize your profits, or you could open another position to hedge your current exposure in case volatility increases in the market. However, if your forecasts are wrong when trading currency correlations, or if the markets move in an unexpected way, you could incur a steeper loss, or your hedge could be less effective than anticipated.
What is the Correlation Coefficient?
The correlation coefficient measures the correlation between different assets – in this case, currency pairs. It ranges from one number to another representing a perfect or negative correlation. For example, Mataf - www.mataf.net uses a correlation coefficient above 80 and positive to indicate that currencies move in the same way. It also uses a correlation coefficient above 80 and negative to show that the currencies move in the opposite way.
Why is it Important to Know if Currency Pairs are Positive or Negatively Correlated?
Currency correlation is important for traders to understand because it can have a direct impact on forex trading results, often without the trader’s awareness. As an example, assume that a trader buys two different currency pairs that are negatively correlated. The gains in one may be offset by losses in the other, which is often used as a hedging strategy. Meanwhile, buying two correlated pairs may double the risk and profit potential, since both trades will result in a loss or profit. They are not fully independent since the pairs move in the same direction.
What Are the Most Highly Correlated Currency Pairs?
The most highly correlated currency pairs are usually those with close economic ties. For example, EUR/USD and GBP/USD are often positively correlated because of the close relationship between the euro and the British pound – including their geographic proximity, and their status as two of the world’s most widely-held reserve currencies.
How to Trade Forex Pair Correlations?
You can trade forex pair correlations by identifying which currency pairs have a positive or negative correlation to each other. In the conventional sense, you would open two of the same positions if the correlation was positive, or two opposing positions if the correlation was negative. This is because if there was a perfect negative correlation between USD/CAD and AUD/USD having a long position on both pairs would effectively cancel each other out since the pairs would be assumed to move in opposing directions. But, if the correlation was perfectly positive, separate long positions on different pairs might help to increase your profits – or it could increase your losses if your forecasts are incorrect.
Final Thoughts
Before entering a trade with multiple positions, refer to a currency correlation chart to ensure that the pairs are positive or negatively correlated. It's important not to assume because some currency pairs may appear to move the same due to have the same base currency, but that is not always the case.
Traders, if you liked this idea and would like to see more education topics, please let me know in the comments! I'd love to hear your opinion! 😉
Correlated
Blood in every street! Stocks, Bonds, BTC, EEM, Oil, Gold, Comm
Simultaneous 2W Red Bars for all the above*. SPY is in pink so it stands out (by popular request).
This is relatively rare p= 0.028: 11 out of 387 bars since GFC
The chart shows the 11 periods with a yellow vertical line. Each asset is shown independently (upper left) as well as a horde (bottom)
Since the choice of ETF's was neither complete nor systematic, the table (top right) shows the 25 largest
ETF's (out of the 1167 in the list) as measured by 21day $Volume (shown in rightmost column)*.
Middle columns show the ETF's return over 1 day (using todays close 9/6/22) and over 5 days.
Lot's of Red.
Hope that's useful, Trade Safe.
Analysis: When the smoke clears and there is time for analysis: What happens after the 11 cases?
Qualitatively, my impression is that volatility (range) stayed high while momentum frequently changed direction (more then I expected)
Also for follow up: when do we (irrationally) expect reversal vs continuation? Positive and negative recency has been studied extensively as the "Gamblers Fallacy" and the "hot hand".
*Notes:
Stocks: $SPY
Bonds: $TLT
Oil: $USO
Commodities: $DBC
Emerging Markets: $EEM
Gold: $GLD
BTC: $BITO IS 2W red as well but is also a new ETF so was omitted from the count.
Currency (DXY) appears independently at bottom.
**Table found on etscreen.com on 9/6/22 (link appears under the table). Its purpose is educational only as specified in "Fair use" section 107 of the U.S. Copyright Act.
Bitcoins next big sell off at 45k?My recent analysis of Silver applies across all commodities. If you are bull on Silver, Gold, Platinum then you are bear on USD. It is quite easy to be bear on USD at this time and it makes sense fundamentally as incentive for companies to return manufacturing to the USA. I have found a distinct correlation between the log scale price of BTC and USD, where USD finds resistance, the log scale price of BTC finds support and vise versa. despite the variations in drawn support for USD, one thing will be constant and that is the resistance BTC finds, whatever USD drops to and travels along as the support, both of BTC resistance lines intersect around the time USD is expected to hit support and that price is at $45K.
If you are wondering why I used a log scale for BTC its because BTC is in a different asset class. It does not behave like other commodities or other currencies. Of the cryptocurrencies, I would go as far to controversially say that bitcoin is not a cryptocurrency anymore, the transaction times are ridiculous and the sentiment is to HODL. HODL like its Gold. Owning Bitcoin in a wallet is like owning real gold, very risky when you need to get rid of it fast and this partially attributes to the lack of a proper bubble burst. The expanding market of crypto cannot be measured against other instruments in the same way. When expansion ends and the market is saturated then comparisons of BTC will really correlate to physical commodities of limited supply and sentiment.
If USD breaks keeps breaking supports then btc will keep finding resistance on the log scale. I actually believe its possible (but absolutely not guaranteed or supported by strong analysis) to hit 150k and crash to 30k in this year, where it can finally be knocked from the top spot in crypto market cap.