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Forex Correlations

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Forex correlations are a key tool. If you have not learnt what they are, It could already be harming your trades. Correlations show which pairs move together. Also, it pinpoints those that move in opposite directions. No less importantly, it will show which pairs are unrelated.

This all helps to judge which trades we should take. It can mitigate risk, and also provide additional trading opportunities not obvious on the price chart.

How To Read Exchange Correlations???
Correlations are normally displayed with values ranging from -100 to 100. A value of -100 (inverse correlations) show two forex pairs that move exactly opposite each other. If one rises, the other falls and vice versa. A figure of 100 means two forex pairs move together. If one rises, the other also rises. Likewise, if one falls the other will also. Figures at the extremes of the spectrum are rare but the closer the number to -100 or 100, the stronger the correlation.

So figures over -/+ 70 are a noteworthy correlation. Anything over -/+80 is a strong correlation. Consider the GBP/USD and EUR/USD crossover above. It gives a figure between the GBP/USD and EUR/USD of 89.6. This shows a strong correlation.

Next, judge USD/CHF with EUR/USD. It shows that the correlation between these two pairs is -95.4. This highlights a very strong inverse correlation. When the EUR/USD goes up, the USD/CHF goes down, and vice versa.

With plenty of pairs, there is no relevant correlation. Where a value (positive or negative) is less than 60 the correlation is not very strong. Anything around 0 shows there is no correlation between the pairs at all. As an example the NZD/USD and the EUR/USD pairs. The correlation here is -1.7. This means there is no discernible correlation, on a daily basis, between these pairs. In other words, the NZD/USD rising or falling tells us absolutely nothing about what the EUR/USD might do.

Correlation Ranges!!!

Correlations tables are created and updated based on hourly, daily and weekly timeframes. All these timeframes provide valuable information depending on what timeframe you trade on. For short-term trading, the hourly and daily correlations will be the most important important. Figures change, so do not take the above as gospel.

Why Forex Correlations Matter?
There are a range of reasons to care about forex correlations. The biggest reason I monitor them is to control risk. For example, a trader might assume trading multiple pairs has offered them diversification. Only by knowing pair correlations, can this be assured.

If you go long (buy calls) in the EUR/USD, GBP/USD and sell (buy puts) the USD/CHF you have essentially taken 3 very similar positions. If one moves against you, they are likely to all go against you. Risk has effectively been tripled. If leverage has also been used, the risk is large.

Another reason why forex correlations matter, is that they can provide you with trades you may not have seen. For instance, you believe the EUR will appreciate against the USD (ie. the EUR/USD will go up). You look at the chart and don’t see a great trade set-up. Since you know that the GBP/USD typically moves with the EUR/USD (based on the current correlation), you can also check out the GBP/USD to see if there is a better trade set-up.

You may also want to see if there is a trade set-up to go short (buy puts) in the USD/CHF since it typically moves in the opposite direction of the EUR/USD. High correlations (positive to negative) provide you with alternative trades; choose the one with the best trade set-up.

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