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Forex Correlation: Using Currency Correlation in Forex Trading
More View more. What is currency correlation? Using currency correlation in forex trading 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. And remember, trading Forex is not a science experiment.
You may want 10 years of data for a science project, where the behavior of objects can be assumed to be consistent. But in Forex, we are measuring human behavior, and while some patterns are consistent over time, more recent behaviors are more pertinent to the immediate future. This sets up a conflict of interest — you want lots of data, but you also want recent data because it is likely to be more relevant to your trading decision.
In Forex, we are always talking about two currencies. A correlated pair will move in the same direction and by nearly the same extent against a third currency.
Forex Pairs That Correlate
This is the case with the euro and Swiss franc. Because of the strong trade ties between European countries and Switzerland, the Swiss franc tends to move in lockstep with the euro against the dollar. The correlation between the euro and Swiss franc against the dollar ranges from Why the minus sign? The answer lies in the quotation convention. Ignore the minus sign when the quotation convention is different — the high number is telling you the euro and Swiss franc move together very tightly.
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If you are buying the euro, you would not want to be selling the Swiss. And in the same line of thought, if you are buying both the euro and Swiss franc, you are essentially doubling your bet against the dollar — you get no diversification at all from trading the euro and Swiss franc together. It is the very essence of diversification that you have one currency with a high positive correlation and another with a high negative correlation.
The correlation of the euro and Swiss franc is so natural and has been going on for so long that a key component of Swiss National Bank monetary policy was to put a floor 1. In , as the euro was approaching parity with the Swiss franc, the Swiss National Bank announced the floor, and its statement of resolve to intervene to enforce the floor was effective. The SNB did intervene on many occasions and has repeated the threat of intervention even more times, but its credibility was rock-solid until it failed on January 15, No one can say whether the downside correction in the EUR to put it in more in line with the upward pace of the AUD was caused by traders noticing that the euro was rising too far, too fast compared with the AUD.
Presumably, there are some traders who trade in this manner, but we do not have any hard evidence or testimony about it. Correlation websites leave a lot to be desired. Periodicity is critical. But on the 6-month basis, the correlation coefficient is only 0. The implication is that if you expect a holding period of six months, you cannot count on the correlation. This means you cannot count on the yen to move in sync with the euro on a short-term basis but over the longer-run, the correlation does exist, even if 0. Be careful what you read.
This is an example of a non-directional arbitrage strategy which exploits currency correlations. Forex strategies based on currency pairs correlation The observation of correlations among currencies can help a trader to hedge or diversify his exposure to the Forex market. Open an Account Open a Demo Account.