Currency Correlation Explained

You can learn more about our cookie policy here , or by following the link at the bottom of any page on our site. Note: Low and High figures are for the trading day. Currency correlation, or forex correlation, denotes the extent to which a given currency is interrelated with another, helping traders understand the price movements of currencies over time and influencing their forex decisions.

Currencies are traded in pairs, meaning no single currency pair is ever isolated. This means traders need to understand how currency pairs move in relation to others, particularly if they are trading multiple pairs at the same time. When using currency correlation in forex trading, traders can gain knowledge of the positions that cancel each other out, so they know to avoid those positions. Traders can also use currency pair correlation for diversifying a portfolio.

More on these strategies will be discussed below. Fx correlation is represented on a numerical scale. A correlation coefficient of -1 implies the currency pair will always move in the opposite direction, while if the correlation is 0, the relationship between the currencies in the pair will be random, with no correlation.

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As an example, a positive correlation of, say, 0. This can be observed in the charts below. The currency coefficient measure can be seen in the red secondary chart, revealing that while the currency pair moves in a similar direction most of the time, it is sometimes negatively correlated. The peaks represent the points in the chart showing positive correlation, with the troughs showing negative correlation.

The currency coefficient shows that while this correlation is mainly negative, it is occasionally positively correlated. Currency correlation tables show the relationship between main forex pairs and other pairs over different time periods but, as seen in the charts above, currency correlations can and do change over time. CHF is a safe haven currency and can appreciate dramatically when economic turmoil hits and equities fall, which is one reason that might explain the negative figures.

Correlation Matrix

Traders typically use currency correlation for inter-market trading, hedging a position, and diversifying risk. Identifying markets that are closely correlated with each other can be useful because, if patterns are not clear in one market, clearer patterns can be used in the second market to help traders place trades in the first.

Since Canada is the largest exporter of oil to the US, the currency pair is sensitive to the commodity price, and when the oil price rises CAD will tend to strengthen against USD. Another example is the correlation of the Australian Dollar AUD with gold, with price rises in the precious metal equating to rises in AUD due to the country being one of the leading gold producers in the world.

Hedging a position is also a reason to trade forex correlations. Traders can also use currency correlation for diversifying risk. In summary, when creating a forex correlation trading strategy, some factors to consider when trading are:.

For more information on currency pair correlation analysis, take a look at our video Building Your FX Trading Strategy. For extra juice in your trading, try combining correlations with sentiment analysis. DailyFX provides forex news and technical analysis on the trends that influence the global currency markets. Leveraged trading in foreign currency or off-exchange products on margin carries significant risk and may not be suitable for all investors.

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By pressing 'Subscribe' you consent to receive newsletters which may contain promotional content. Check your email for further instructions. Live Webinar Live Webinar Events 0. Economic Calendar Economic Calendar Events 0. Duration: min. P: R:. Search Clear Search results. You can compare each currency on the y-axis to those on the x-axis to see how they are correlated to one another.

Monitoring currency correlations is important because, even in this small table of currency pairs, there are several strong correlations. However, because the pairs have a high negative correlation, they are known to move in opposite directions. Therefore, the trader will likely end up winning or losing on both, as they are not fully independent trades. Correlation allows traders to hedge positions by taking a second trade that moves in the opposite direction to the first position.

A currency hedge is achieved when gains from one pair are offset by losses from another, or vice versa. Therefore, buying or selling both creates a hedge.

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For someone trading gold and holding positions in other currency pairs, this type of analysis is important. This is because both Canada and Japan are major oil importers. Commodities can hedge or be hedged by currencies when there is a strong correlation present in the same way that currencies hedge each other. A commodity may move much more in percentage terms than a currency, so gains or losses in one may not be fully offset by the other.

Read our commodity guides on oil trading and gold trading. A pairs trade involves looking for two currency pairs that share a strong historical correlation, such as 80 or higher, and taking both long and short positions on the assets. A trader can buy the currency that is moving down and sell the currency pair that is moving up.

The idea of this is that they will eventually start moving together again, given their long history of a high correlation. If this occurs, a profit may be realised. Therefore, some traders may place a stop-loss order on each position to control the loss. Ideally, the bought pair would move up and the sold position move down as the pairs mean-revert , which could result in a profit on both trades.

When using any currency correlation strategy, and any strategy, position sizing is a key component to risk management. Based on where the stop loss is placed, many traders opt to risk a small percentage of their account, for example, if the stop loss is reached.

This way, the risk on the trade and risk to the account is controlled. Currency pairs are non-correlated when they move independent of each other. This can happen when the currencies involved in each pair are different, or when the currencies involved have different economies. Therefore, they tend to move together in the same direction, although this is not always the case, as we will see further on in the article.

Therefore, the correlation between these pairs tends to be lower. To start trading forex correlations pairs, all you need to do is the follow the below steps:. Place your trade. Decide whether to buy or sell and determine entry and exit points. While a number of currency correlation strategies have been discussed in this article, using them on a trading system means defining exact entry and exit points, both for winning and losing trades.

On our platform, any currency can be dragged from the product list onto an existing chart of any currency pair to show both currency pairs on the same chart. These pairs typically move together, but in this example, they moved in opposite directions.

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This set up is a potential mean-reversion trade. There is no default currency correlation indicator for MetaTrader 4 MT4 ; however, it does have a vast library of downloadable indicators in the Market and Code Base sections of the platform. These are often created and shared by third party users, so some indicators may be better than others.

Some are also free, while others come at a cost. These can be installed to the MT4 platform easily. Open an MT4 account now to get started. Seamlessly open and close trades, track your progress and set up alerts. CMC Markets is an execution-only service provider. The material whether or not it states any opinions is for general information purposes only, and does not take into account your personal circumstances or objectives.

Nothing in this material is or should be considered to be financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.

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