Understanding the correlation between currency pairs is very important as currencies are priced in pairs and not independently. Some pairs may generally move in the same direction while some in opposite. Knowing the correlation is important to avoid simultaneously entering the market with multiple pairs which may cancel each other's profitablility.
Let's say the currency pair "X" moves in the same direction as pair "Y" and we have been following up pair X's move closely. We expect it to go down and and we short-sell it. We have not been following up pair "Y" so closely and suddenly we look into the movement of pair "Y" and because of fundamentals and/or technical analysis we feel that that this pair may go up. We decide to buy currency pair "Y". What eventually may happen that we may end up making profit on one pair and loss on the other as they moved in same direction. Similar case would happen if we simultaneously go long or short on two pairs which move in opposite directions.
Once we know about the correlations between currency pairs and their changes with time, we can take advantage of them to control the exposure of our portfolio.
The correlation coefficient ranges between -1 and +1.
Correlation of +1 : Movement in the same direction all the time.
Correlation of -1 : Movement in the opposite direction all the time
A correlation of zero: The relationship between the currency pairs is completely random.
Positive Correlation:
A positive figure which is less than +1 means that the currency pairs generally move in same direction but not all the time. A value closer to +1 means that most of the time they move in the same direction
Negative Correlation:
A negative figure but more than -1 means that the currency pairs generally move in opposite direction but not all the time. A value closer to -1 means that most of the time they move in opposite directions.
How to use currency correlation ? Suppose two currency pairs move in the same direction and have been moving up with a correlation over 0.60 in the long-term and we find that suddenly the correlation value in during the past few days has become 0.20, we just see which currency pair's movement (increase is slow) and we could buy that. On the other hand we could short-see another currency pair.
For calculating currency correlation and having a graphical representation, please visit Trading Tools section of ForexAbode.com
Disclaimer: Trading has it's own risks and no analysis can assure you that it would prove to be correct 100%. We need to work innovatively to make strategies which have less risks and more gains.
Let's say the currency pair "X" moves in the same direction as pair "Y" and we have been following up pair X's move closely. We expect it to go down and and we short-sell it. We have not been following up pair "Y" so closely and suddenly we look into the movement of pair "Y" and because of fundamentals and/or technical analysis we feel that that this pair may go up. We decide to buy currency pair "Y". What eventually may happen that we may end up making profit on one pair and loss on the other as they moved in same direction. Similar case would happen if we simultaneously go long or short on two pairs which move in opposite directions.
Once we know about the correlations between currency pairs and their changes with time, we can take advantage of them to control the exposure of our portfolio.
The correlation coefficient ranges between -1 and +1.
Correlation of +1 : Movement in the same direction all the time.
Correlation of -1 : Movement in the opposite direction all the time
A correlation of zero: The relationship between the currency pairs is completely random.
Positive Correlation:
A positive figure which is less than +1 means that the currency pairs generally move in same direction but not all the time. A value closer to +1 means that most of the time they move in the same direction
Negative Correlation:
A negative figure but more than -1 means that the currency pairs generally move in opposite direction but not all the time. A value closer to -1 means that most of the time they move in opposite directions.
How to use currency correlation ? Suppose two currency pairs move in the same direction and have been moving up with a correlation over 0.60 in the long-term and we find that suddenly the correlation value in during the past few days has become 0.20, we just see which currency pair's movement (increase is slow) and we could buy that. On the other hand we could short-see another currency pair.
For calculating currency correlation and having a graphical representation, please visit Trading Tools section of ForexAbode.com
Disclaimer: Trading has it's own risks and no analysis can assure you that it would prove to be correct 100%. We need to work innovatively to make strategies which have less risks and more gains.