Professional traders know that there are many factors to consider when it comes to building a complete trading strategy. One of these factors is the degree of correlation between several currencies. Today we are investigating some of the most popular currency pair correlation trading strategies and how to apply them effectively.
Meaning of currency pair correlation
For a beginner trader it may seem that all the world’s currencies are following their own path. Because simple logic suggests that if all pairs move equally, their values will be the same. However, the price movement is more a symptom than a cause. Which means that there are many components in the Forex price combination and, what’s more, they all have connections to each other and some are even able to affect the movement throughout the market.
Which brings us to the starting point: understanding all the impacting factors and using them in your negotiation process is a tremendous asset. The Forex currency pair correlation strategy, for example, suggests that betting on currencies that agree with each other can serve as an augmentation tool and take your earnings to a new level. But before we get into the technical aspects of correlation-based trading, let’s first look at ways to track the relationship between the chosen currencies.
Expert traders are able to continue on the ways in which currency pairs affect each other for hours. The fundamental analysis of the market tells us that each particular currency has a base to support itself and that base consists of many contributing elements. Undoubtedly, the more time you spend on Forex, the better you will have to understand how each part of the mechanism works. But at first, there is no need to dig too deep.
The main tool for Forex strategy correlated pairs is the correlation matrix. It is an interactive range that presents all the currencies traded and the degree of correlation between each of them. There are two important things to remember about how this Matrix works: one, the numbers are calculated through a preset formula that analyzes how the average values of the currency pairs considered are compared. And two, The Matrix is always changing, just like the price values. Therefore, to effectively implement any Forex correlation pairs strategy, you should consult the matrix on a regular basis.
Trading strategies using inverse correlations
There are several approaches to the use of correlation in trade. The first is intuitive: when two pairs are correlated it means that when one goes up, another also does. Therefore, if a trader opens a long position in both pairs, the profit from the result has a great chance of doubling. An additional advantage of this approach is diversification, through which a trader can slightly reduce the overall risk and still keep the approach in a specific direction.
Another approach is Forex pairs trading strategies using inverse correlations. When you look at the correlation matrix, you will notice that the range goes from 1.0 to -1.0, translated to the percentage will be from 100% to -100% or completely correlated and not correlated at all, respectively. Some runners will also Code The Color of the matrix to go from deep green to deep red, to make it easier to read.
So when we look at the pairs that oscillate below zero, we’ll see those that are close to being completely unrelated, like EUR / USD and USD / CHF. Opening a long position in both pairs simultaneously can be a good solution to reduce volatility-based risk exposure in one pair. When one pair moves from rising to a downward move, wait for the unrelated pair to counteract progress and cancel any losses caused. In this way, although you are not earning more than expected, you are losing significantly less or nothing at all.
When choosing a Forex currency pair correlation strategy, consider several combinations of pairs before entering. Your success can be affected by the angle at which the correlation varies, so remember to check back with The Matrix or even learn how to calculate the correlation yourself. The bottom line is that every Forex pair correlation strategy in Forex is as effective as any other approach. It is their job to consider all the underlying ups and downs and come up with their own way of applying the trading method in action.