Корреляция На Форекс Хедж

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Forex Correlation Pairs - Cheat Sheet, and Excel Tutorial

Currency Correlations in Forex Trading

Forex correlations or currency correlations is a way for traders to identify whether one currency pair/ forex pair will move similarly to another currency pair.

A positive correlation is represented by two currency pairs going up at the same time or down at the same time.

However, if one currency pair moves opposite to the other i.e. one goes up and the other goes down this is known as a negative correlation.

Currency correlations are important to monitor and understand not only when analysing price but also when analysing any other commodity, stocks or instrument. In this article, we will look at how forex currency correlations is determined, how to calculate it yourself using excel and how it affects trades.

What do correlated forex pairs mean?

Currency pairs are correlated when they move dependent of each other. This can happen when the currencies in each pair are the same or include the same economies.

For example, EUR/USD and GBP/USD both contain USD as a common factor. On top of this the Eurozone and Great Britain are closely tied economies trading together. These factors are a core reason of a correlated forex pair.

EURUSD vs GBPUSD (Positive Correlation)

This means you'll tend to see most USD currency pairs move in the same direction if the USD is on the quote side of the exchange rate i.e. AUD/USD and NZD/USD will also be a correlated forex pair.

NZDUSD vs AUDUSD (Positive Correlation)

You'll tend to see however that some correlated forex pairs will have a weaker or stronger relationship. This is because all these currencies are separate economies, they all sell different things and affect the exchange rates in different ways!

What do non-correlated forex pairs mean?

Currency pairs that are non-correlated move independent of each other. This generally happens when the currencies in two separate pairs are completely different or are from different economies respectively.

EURGBP vs GBPNZD

For example, EUR/USD and GBP/NZD. These two currency pairs are non-correlated as they don't include any common currency between them and it's 4 separate economies (Eurozone, US, UK and New Zealand). This means there's a good chance that if one grows there's no correlation for the other to grow too.

Trading Currency Correlations

Forex traders will use currency correlations to either hedge their trades, increase their risk or use it for creating value via commodity correlations. There are various ways to trade currency correlations.

Traders will use a currency correlation to potentially increase their profits. For example, since GBP/USD and EUR/USD are positively correlated a trader might place a long trade on both to utilise the relationship.

Advantage:

Potentially increase returns over more currency pairs

Disadvantage:

On the other hand, traders may be more risk averse and opt to use currency correlations to reduce risk. For example, instead of placing a max position size on EUR/USD the trade may split 50% of the position size on EUR/USD and the other 50% on GBP/USD.

Advantage:

Potentially reduce risk by splitting across more economies.

Disadvantage:

Transaction costs are higher

Alternatively, a trader may use correlation to assess a value of a currency pair. For example CAD pairs are highly correlated to Crude oil prices (WTI).

The trader may analyse that if WTI prices rise there's an expectation that CAD prices may also rise. Therefore, not directly trading the correlation but using the correlation within their analysis.

Which Forex Pairs are Most Correlated?

In the correlation table above we've highlighted 5 of the major currency pairs to get the top 5 forex correlation pairs in a view.

Top 5 currency correlation pairs

AUD/USD vs NZD/USD = 87% correlated
EUR/USD vs GBP/USD = 89% correlated
EUR/USD vs USD/CHF =% correlated
GBP/USD vs USD/CAD = % correlated
GBP/USD vs USD/CHF = % correlated

Forex Correlation Cheat Sheet

What we can see in the correlation table is that there are positive and negative correlations.

If we look at the top row of AUDUSD we can see it is 56% correlated to EURUSD at the time of writing this post but also it has a 87% correlation to NZDUSD!

You might notice however, there are negative correlations in there too.

This generally happens when the quote currency is on the base currency between the analysed instruments. For example. AUD/USD vs USD/JPY correlation, USD is on the quote (right hand side) for AUD/USD but it's on the left (base currency) for USD/JPY. This generally creates an negative correlation as it's essentially flipped upside down!

Commodity Currency Correlation

Commodities also have correlations between currency pairs and are used widely when forex trading. It's a great way of assessing the overall risk sentiment of investors/ traders.

For example, XAU/USD (Gold) vs SPY (US stock market) shows a negative correlation. This relationship shows the risk appetite of investors.

GOLD vs SPY (S&P US Stock Market)

If the prices of Gold rise stocks tend to fall, this would be a risk off sentiment for investors, meaning, investors would rather hold a safer less volatile asset over riskier volatile assets.

On the flip side, if Gold prices fall stocks tend to rise indicating the opposite a risk on environment. Investors are willing to take on more risk, they're optimistic about future gains and move their money from safer assets like gold to stocks to make more money.

These commodity correlations apply to forex too as there are risk currencies and safe currencies.

Safe vs Risk Currencies

Safer currencies are the likes of: USD,JPY and CHF.

Risk currencies could be exotics like: MXN, ZAR and potentially even NZD/AUD/CAD.

Gauging the risk sentiment of the market is important for forex traders to not be on the wrong side of trades during the risk on/off environments.

How to Calculate Currency Correlations - Excel Template

Calculating the correlation mathematically is super easy with the use of excel and spreadsheets. In this part of the article we'll cover our excel template on working out the correlation of data you paste in. This can be between any forex pair, commodity, bond or stock.

Remember the markets are interlinked so it's always useful analysing factors outside of currencies to generate your ideas.

Step 1. Copy and paste price data into Data set 1 & 2

Currency Correlation table

In step 1 you can see in the calculator the only data you need to find is the price data of the currency pair or instrument you want to analyse.

In this example we've compared EUR/USD and AUD/USD against each other.

To do that we've pasted in historical price data of EUR/USD into the red section 1 on the left, then pasted in historical price data of AUD/USD into the right hand side section 2.

The formula column will automatically calculate how much the price has increased or decreased.

Step 2. Analyse the correlation

Correlation chart

The next step is changing the sheet to our automatic chart maker and correlation.

This page is all done for you so don't worry about making the chart yourself or calculating the mathematical correlation value.

It's all calculated based on the previous steps; the data pasted in beforehand.

Once you've figured out whether there's a positive correlation or a negative correlation you know which way trades will be if you wanted to trade a correlated pair.

Alternatively, you can use the calculator in a systematic plan to calculate the value. This is what the beginner forex course learning portal covers.

And here's a tip from our CEO:

To increase your success rate, try to make sure their is a very low correlation between all of your trades. This means each individual trade has it's own merit to succeed, without exposing risk too much risk to one idea. - Marcus Raiyat, Founder & CEO of Logikfx

Now you should know all you about currency correlations and forex correlations, how they're utilised by traders and how you can do the same using the calculator above to generate great ideas.

How to Hedge With Multiple Currencies

If you’re an investor, you are likely to be better off if you hedge. With hedging, you can protect the value of your portfolio from unexpected price swings in different ways. Hedging strategies are often used to keep the value of a company’s stock constant when it is selling stock to the public.

Another example is in the financial industry, where many banks and insurance companies hedge the risk of interest-rate fluctuations by using derivatives and other financial tools.

When the market seems volatile and you want to get a better grip on your investments, then hedging proves to be an excellent move that can give you a sense of control despite the adverse price movements.

With that in mind, how do you hedge in forex trading?

Forex Hedging: What is It?

Forex hedging is a concept that is not common with traders. To be able to understand how to hedge in forex trading, it is necessary to first understand what hedging is. In general, hedging is the practice of offsetting risk. You can hedge against currency risk by opening an opposite transaction or contract that minimizes the effect of price changes on the profitability of your original investment.

For example, if you purchase a foreign currency at today’s price to pay for an item in the future, your profits will be reduced if the value of that currency falls before the time of payment.

To protect the value of the original investment, you can sell the same amount of the currency forward for a delivery date after the purchase date. Hedging the value of the currency is a way of protecting the value of your original investment.

The Pivotal Role of Currency in Forex Hedging

You can hedge against price fluctuations by opening a position in a different currency that has lesser volatility. This is one of the most widely used methods in forex hedging. When you do this, you are protecting the value of the original investment.

The more volatile the forex pair is, the harder it is to hedge. A good hedging example is the EUR/USD, which is the most-traded currency pair. EUR/USD is a currency pair and it means the value of the euro in terms of dollars. The euro is one of the most volatile currencies, and this means that it is difficult to hedge using the same pair.

How Does Forex Hedging Work Exactly?

There is no one-size-fits all approach to forex hedging. This is because there is no perfect hedge. It depends on the individual trader or investor’s goals.

In forex hedging, you can hedge yourself by buying a currency that’s not subject to the price volatility of the currency you’re currently trading. This is a great way to hedge currency risk without having to worry about the foreign exchange market too much.

For example, you can buy one currency pair in order to hedge risk in another currency pair. It is a good idea to use the same timeframe, i.e. hours, days, or weeks.

Theoretically, the currency pairs with the least volatility of the two currencies in the pair will have minimal price change and you will be able to make a profit. This is the case even when there is a downturn in the market.

In any case, the longer the contract is in vernacular terms, the more it will vary in value. If you’re going to trade in foreign exchange for the long term, it is a good idea to adjust your hedging strategy.

What Are the Types of Forex Hedging?

There are many types of hedging. Some of them are very similar, while others aren’t. The simplest of all is just a short position in the currency pair. For example, if you want to hedge your long position in the EUR/USD, you can open a short position in the same pair. This yields the exact opposite price movement of the first pair.

If you want to hedge your position, and you want to make a profit out of it, then this trade will give you the exact opposite price movement, since your long and short positions cancel out each other.

Another hedging technique is a cross hedge. The example to follow is an investor who has a long position in the GBP/USD. He decides to hedge his position by shorting the NZD/USD. This is a short position in the opposite direction. Hedging with the NZD/USD is the same as adding a long position in the GBP/NZD. The long position in the GBP/NZD will hedge the GBP/USD.

A major advantage of this method is that it’s easy to understand and it takes only a few minutes. The disadvantage is that the two pairs have to have an opposite correlation. If they don’t, then you will cut down on your profit.

What are the Benefits of Forex Hedging?

Benefit #1: Higher Control Over Risk/Reward Ratio

Forex hedging can reduce your exposure to price changes. Your position will reduce the overall profit and loss, making it easier for you to understand if you’ve made a good or bad investment.

Benefit #2: Promotes Diversification

The main benefit of forex hedging is diversification, which is a great way to manage and control risk-taking. If your trades are diversified, you will be able to hedge against downside risk and protect your portfolio against price fluctuations.

Benefit #3: Serves as an Insurance Policy

Another good reason to use hedging is that it serves as an insurance policy. Sometimes, you can be uncertain about the costs of your position for a long time. You don’t need to be worried about this when you use hedging.

The longer the contract is, the more it will vary in value. If you’re going to trade in foreign exchange for the long term, it is a good idea to adjust your hedging strategy.

Benefit #4: Enables You to Avoid Overpaying

You may be able to find opportunities to increase your income by taking advantage of currency fluctuations. For example, if you have a long position and the price goes down, you can use the same amount of money to open a short position.

If the price goes up, you’ll earn a profit on your short position. If it goes down, you will lose money on your long position, but you’ll also make money on your short position. This way, you’ll balance out the loss and make a profit.

Benefit #5: Matches Your Position with an Uncertain Economic Situation

You can also use forex hedging to match your position with a specific economic situation. For example, a currency may experience increased volatility when the economy is in a slump, or if there is an adverse government announcement, or if a central bank is in the news.

As you can see, there are many benefits to using forex hedging. They help you control your risk and make trading simpler and less stressful. You will also be able to make a profit, even when there are adverse price movements.

What are the Drawbacks of Forex Hedging?

Forex hedging is not an end-all-be-all solution, so just as it comes with its advantages in certain situations, it may also lead you astray in your investments when done at the wrong timing. With that in mind, here are examples of the potential disadvantages of hedging in forex:

Drawback #1: Reduced Profit Potential

The main drawback of hedging is that it limits your upside potential. This can be beneficial when you have a short-term goal and you have a set investment amount to keep, but if you’re looking for long-term profits, you may want to opt for other investment methods.

Instead of trading with the trend and more importantly, knowing when to exit a trade, you are in danger of locking in your profit and missing out on future increases in the price. As soon as you lock in a profit on a trade, you can’t re-enter that trade until the price falls again.

Drawback #2: Lack of Expertise to Make the Most of Hedging

A lot of people believe that forex hedging is a shortcut to making money, but it may lead to unintended risk and loss. Hedging may sound great in theory, but it is not easy to do in practice. To make the most of hedging, you need to practice it regularly. When you make mistakes and don’t hedge properly, it can be disastrous.

When you use hedging in forex, you will be trading two positions. It is important to look at both positions and make a profit on both of them. Otherwise, you will lose money.

Drawback #3: High Risk of Loss in a Volatile Market

Hedging is a tool that can be used to manage your risk, but it can also be a double-edged sword. For example, you can use shorter-term hedging to lock in your profits. This may sound great in theory, but it can lead to a loss if you don’t do it correctly.

The Best Times to Consider Hedging in Forex

Hedging can be used at any time, depending on what your goals are. If you want to practice and get better at it, it is better to do it during the market’s low volatility periods.

Depending on your goals, you can consider using forex hedging when:

You want to limit your risk of losing a high amount of money.
You want to lock in profit on your trade.
You want to practice hedging to see if this is a strategy you want to use as a regular trading method.
You want to make sure you don’t miss trading opportunities.
You want to practice a specific strategy or strategy that you haven’t used before.

If you’re new to trading, it is important that you take a careful look at each one of these situations, so you can understand the impact of hedging on your trading and determine which one is the best move for you.

How to Properly Exit a Hedge

To be able to properly exit a hedge, you will first need to decide which one you want to exit, if you want to exit both, or if you want to remain in both positions for a long time. It is important that you use your trading strategies and strategies to determine your exit point. The more you practice, the better you will be at knowing when to exit a trade.

Exit Strategy 1: Exit Strategically

If you have exited one of the positions and are going to exit the other one, but you are not sure when to exit, you should use the following exit strategy:

Calculate the percentage of risk you have in the position. This is different for each individual trader, so you will have to experiment to find what works for you.
Test different exit strategies until you find one that works for you.
Monitor the position to ensure that you’re getting out of the trade at the right time.

Exit Strategy 2: Exit When You’ve Made a Profit

Once you have decided to exit one of your positions, you’ll need to figure out when to exit the other one. To do so, you can use the following exit strategy:

Calculate the percentage of profit you have in the position.
Set an amount of time that you want to wait before you exit the other position.
Monitor the position to ensure that you’re getting out at the right time.

The Bottom Line: Knowing When to Spot the Window of Opportunity for Hedging in Forex

Hedging is risky, no matter how you look at it. If you don’t have an expert’s knowledge and experience, you may need to do a lot of research and read a lot of books to get a better understanding of the strategies. If you’re a beginner in forex, you may want to steer clear of hedging.

Many people will tell you that you can make money by hedging in forex, but if you don’t know what you’re doing and you don’t know how the market works, you may end up hurting your portfolio. You should only hedge your position with the help of a professional.

There are many reasons you may want to hedge your position. You may want to reduce risk, protect your profits, or feel more comfortable with your investment. Whatever the reason may be, you should always consult with a professional to help you understand the foreign exchange market better.

How Can We Help You?

Bound is an auto hedging platform designed to make currency protection better and more effective for businesses in various industries. If you're interested in FX for business, reach out to us today!

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Hedging in forex trading is a strategy where you open additional positions to protect against adverse movements in the foreign exchange market, typically involving the buying or selling of currency pairs to offset potential losses in another position. Essentially, it's a risk management technique used to reduce or balance the exposure of an existing position.

Currency Hedging to manage risk

Currency hedging is used to manage risk by strategically opening positions that counterbalance potential losses in your existing forex investments. For instance, in a direct hedge, you might open a position opposite to your current trade in the same currency pair. This method, often referred to as a perfect hedge, effectively neutralises both risk and potential profit as long as the hedge is active.

Although the net profit from such a hedge is typically zero, it enables you to preserve your original market position, poised to capitalise on any trend reversals.

Hedging with Forex options

To hedge with forex options, you purchase options contracts like puts or calls to limit risk on existing positions, with the flexibility to choose whether to execute the trade based on market movements.

Hedging with forex options is a strategic approach to managing currency risk in your trading portfolio. By purchasing options contracts, such as puts or calls, you gain the ability to limit risk on existing positions, with the added flexibility to decide on executing the trade based on anticipated price movements in the forex market.

Let's say you're holding a long position in a currency pair but are concerned about potential negative price movements that could lead to a decline in value. In this scenario, you can buy a put option. This option contract gives you the right, but not the obligation, to sell the currency pair at a predetermined price before the option's expiry. This strategy effectively caps your downside risk, ensuring that even if the market moves against your position, your losses are limited to a known amount.

Conversely, if you have a short position in a forex pair and there's a risk of an upward price movement, buying a call option can be a prudent move. A call option gives you the right to buy the currency pair at a specific price before the option expires. This way, if the currency pair's value rises, you can exercise your option to buy at the lower, predetermined price, thus mitigating your risk.

Using forex options for hedging not only helps in managing the risks associated with adverse price movements but also provides a way to stabilise cash flows, especially in scenarios where currency fluctuations are significant.

The key advantage here is the flexibility options offer; you are not obligated to execute the trade if the market moves in your favour, allowing you to benefit from favourable conditions while having a safety net in place for adverse movements. This dual benefit makes forex options a powerful tool in the arsenal of forex traders looking to hedge currency risk effectively.

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What are the benefits of Hedging?

The primary benefit of hedging in forex trading is its ability to mitigate potential losses in a volatile market, particularly in response to unpredictable events or significant news that can trigger currency fluctuations. Forex hedging serves as a strategic tool for you to manage risk, offering a layer of protection against adverse market movements.

However, it's crucial to recognise that employing hedging strategies, especially those involving multiple currencies or options, can introduce additional risks and costs. As such, a thorough understanding of the fx market and meticulous planning are essential for effective hedging.

Benefits of Fx Hedging include:

What is Hedging in Forex Trading?

Forex Hedging strategies

In the dynamic world of forex trading, hedging strategies are crucial for managing risk and enhancing the stability of your portfolio. From simple methods involving direct hedges to more complex strategies using correlated pairs and options, these techniques offer a spectrum of approaches to safeguard investments against market volatility.

Let's delve into examples of both simple and advanced fx hedging strategies to help you understand how they function in real-world scenarios.

Simple Forex Hedging example

Suppose you have a long position in Great British Pound vs US Dollar (GBP/USD) at a bid price of and an ask price of To hedge this position, you decide to open a short position on GBP/USD simultaneously. The bid price for the short position is , and the ask price is

This direct hedge means that any losses in your long position due to a decrease in GBP/USD will be offset by gains in your short position, and vice versa. However, the spread between the bid and ask prices (3 pips in this case) represents a cost, and typically, the net result of such a hedge is zero profit. The primary goal here is to protect existing gains or minimise potential losses from significant currency fluctuations.

Advanced Hedging example

To illustrate a more advanced hedging technique, let's say you take a long position in Euro vs US Dollar (EUR/USD) at a bid price of and an ask price of Simultaneously, you open a short position in a positively correlated pair like US Dollar vs Swiss Franc (USD/CHF), with a bid price of and an ask price of The correlation between EUR/USD and USD/CHF means that if EUR/USD falls, causing a loss in your long position, this loss could potentially be offset by a gain in your short position in USD/CHF, and vice versa.

Additionally, you might enhance your hedging strategy by using forex options. For instance, holding the same long position in EUR/USD, you could purchase a put option with a strike price of , paying a premium (the cost of the option).

If EUR/USD falls below this strike price, you can exercise the option to sell EUR/USD at , thus limiting your downside risk. This strategy caps potential losses while allowing you to benefit from favourable movements in EUR/USD, but it's important to consider the cost of the option premium in your overall strategy.

Both simple and advanced forex hedging strategies are vital for managing risk and volatility in the forex market. They offer protection against adverse market movements but require an understanding of market dynamics, including the impact of bid-ask spreads and the costs associated with options trading.

As with any trading strategy, there's no guarantee of profit, and these strategies should be used as part of a comprehensive risk management approach.

Other risk management strategies

In addition to hedging, there are several other risk management strategies that forex traders can employ to protect their investments and enhance their trading performance.

1. Use stop-loss and limit orders

Stop-loss orders are essential for managing risk. They automatically close a trade at a predetermined level to prevent further losses. Similarly, limit orders can be set to secure profits by closing a trade once it reaches a certain profit level. These tools help traders to define their risk and reward parameters clearly, ensuring they don't expose themselves to unnecessary risk.

2. Risk tolerance assessment

Before starting to trade, it's crucial to assess your risk tolerance. This involves considering factors like your age, trading experience, knowledge, and the amount you're willing to lose. Trading within your risk tolerance helps in making informed decisions and reduces the likelihood of taking impulsive, high-risk trades.

3. Risk/reward ratio

Setting a minimum risk/reward ratio, such as or , is a common practice among successful traders. This ratio helps in setting stop-loss and take-profit orders effectively, ensuring that potential rewards on a trade are always higher than the risks.

4. Control risk per trade

A conservative approach to risk per trade, especially for beginners, is crucial. A common guideline is to risk no more than 1 per cent of your trading capital on a single trade. This strategy helps in preserving your capital over the long term, even during a series of losing trades.

5. Consistent risk management

Maintaining consistency in risk management is vital. Avoid the temptation to increase your position size or risk more capital after a series of successful trades. Stick to the risk management rules set in your trading plan.

6. Leverage and margin management

Understanding and controlling leverage is crucial in forex trading. High leverage can amplify profits but also magnify losses. It's important to use leverage wisely and be aware of the margin requirements of your trades.

7. Currency correlations

Be mindful of currency correlations. Trading multiple forex pairs that are highly correlated can inadvertently increase your risk exposure. Diversify your trades and understand how different currency pairs move in relation to each other.

8. Diversify your portfolio

Diversification is key in managing risk. Don't concentrate all your capital in a single currency pair or trading strategy. Spread your risk across different forex pairs and trading strategies to mitigate the impact of any single losing trade.

9. Emotional control

Managing emotions is a critical aspect of risk management. Avoid making trading decisions based on fear or greed. Stick to your trading plan and don't let emotions drive your trading decisions.

Continuous education

Stay informed and continuously educate yourself about the forex market and risk management strategies. The more knowledgeable you are, the better equipped you'll be to make informed trading decisions and manage risks effectively.

Incorporating these risk management strategies into your trading routine can significantly enhance your ability to protect your capital and achieve consistent trading success. Remember, effective risk management is the cornerstone of successful forex trading.

About foreign exchange markets and Hedging

The foreign exchange market, the largest financial market globally, is valued at $ quadrillion, with a daily global forex trading volume reaching $ trillion as of April

One of the major appeals of the forex market is it continuously operates 24 hours a day and encompasses over different currencies. The majority of the trading volume is concentrated in seven major currency pairs, which account for 85 per cent of forex market activity.

Major financial participants, including multinational corporations, hedge funds, and investment managers, utilise the fx market to hedge against foreign exchange risk. To manage this risk, companies often use forex hedges, such as forward contracts and options.

A forward contract locks in an exchange rate at which the transaction will occur on a future date, while an option sets an exchange rate at which the company may choose to exchange currencies, providing the flexibility to not exercise the option if the current exchange rate is more favourable.

Tips for beginners Forex trading

For those starting in forex trading, understanding the market and effective risk management are paramount. Before diving into trading, it's crucial to educate yourself about the forex market, including the dynamics of forex pairs and the factors influencing them. This foundational knowledge is an investment in itself, potentially saving you from costly mistakes.

For beginners in forex trading, the journey starts with education and understanding of the market. A well-thought-out trading plan, practice, and a disciplined approach to risk management are essential steps towards successful trading. Remember, forex trading involves significantly high risk, and it's important to approach it with caution and informed strategies.

FAQs

What are Forex CFDs?

Forex CFDs, or Forex Contract for Differences, are financial derivatives that allow traders to speculate on the price movements of currency pairs without actually owning the underlying asset.

In Australia, when retail traders engage in foreign exchange markets via brokers, they are trading forex CFDs. You can trade various financial instruments such as CFDs, including shares, indices, commodities, and crypto.

What is the Currency Correlation Hedging strategy in Forex?

The Currency Correlation Hedging Strategy in Forex involves opening positions in currency pairs that are positively correlated, such as going long on one pair and short on another, to offset potential losses. This strategy is based on the understanding that some currency pairs move in tandem due to economic or geopolitical factors.

For example, a trader might go long on EUR/USD and short on USD/CHF, as these pairs often exhibit negative correlation. When one pair moves in a certain direction, the other is likely to move in the opposite direction, thus hedging the risk. This approach is particularly useful in volatile markets, as it balances positions that act as a hedge against each other. It's also a way to diversify trading strategies and manage overall risk exposure more effectively.

What is the difference between hedging and arbitrage?

The difference between hedging and arbitrage is that hedging involves taking opposite positions in the market to limit investment risk, while arbitrage exploits price differences between markets for profit. Hedging is used to reduce the risk of serious investment losses by engaging in concurrent bets in opposite directions, often using derivatives like options and futures. It aims to protect against market volatility but does not seek risk-free trades.

On the other hand, arbitrage involves buying and selling the same asset in different markets to capitalise on price discrepancies. It is typically a short-term strategy and can be risk-free if executed correctly, assuming no transaction costs.

Arbitrage opportunities are found with various financial instruments, including forex, bonds, interest rates, and equities, but have become more challenging with the advent of high-speed trading and instant price information access. Both strategies are crucial in financial markets for price discovery and risk management but serve different purposes and involve different risk profiles.

Disclaimer: This article is for informational purposes only and should not be considered as financial advice. Always conduct your own research and consult with a financial advisor before making any investment decisions.

Disclaimer: This story may include affiliate links with PropCompanies partners who may be provided with compensation if you click through. ACM advises readers consider their own circumstances and needs. You should verify the nature of any product or service, and consult with the relevant regulators' website before making any decision.

Currency correlations: what are they and how can you trade them?

Published on: 12/07/

What is Currency Correlation?

Currency correlations help trade multiple currencies in the forex market by identifying the market trends of each currency pair. It also provides traders with opportunities to amplify their profits and hedge the forex positions by opening similar or opposite orders, respectively. In this article, take a look at currency correlations in-depth.

What is currency correlation in forex?

A forex correlation refers to the relationship between two different currency pairs–which can either be positive or negative.

Positive correlation

When two currency pairs have a positive correlation, they are positively impacted by each other and move in the same direction. For example, one of the most correlated currency pairs in the forex market is EUR/USD vs GBP/USD. If you open a long trade in both these currency pairs, a positive movement can potentially double your profits, but a fall can also potentially double the risks as well.

Negative correlation

When two currency pairs have a negative correlation, they are negatively impacted by each other and move in the opposite direction. A positive movement in one currency pair leads to a negative movement in the other currency pair and vice versa. This is why negatively correlated currency pairs can be used as a hedging strategy as a loss in one currency pair can be offset by profits in the other. An example of negative correlation is EUR/USD vs USD/CHF. If you open a long position in EUR/USD but the markets fall, you can quickly open a short position in USD/CHF to hedge the risk.

Non-correlated currency pairs

These pairs have no relationship with one another and do not affect each other’s movement. An example of non-correlated currency pairs is EUR/USD and GBP/NZD.

What is the correlation coefficient?

Correlations can be strong, weak or non-existing. A correlation coefficient helps in determining if the correlation between the two currency pairs is strong or weak, and to what extent. In forex, the value of the correlation coefficient ranges from to

When the value of a correlation coefficient is in the range, it indicates that the currency pairs move almost identically in the opposite direction.
When the value of a correlation coefficient is in the range, it indicates that the currency pairs move identically but in the same direction.
When two currency pairs move in the same range, that is, for example, below and above 50, it means that they have a strong negative correlation.
If both the currency pairs move above 50, they are said to have a strong positive correlation.
If a currency pair moves below but above 20, the two are said to have a negative correlation, but the strength of the correlation is weak.
When a currency pair moves above 20 and the other moves above 80, they are again positively correlated, but the strength of the correlation is again weak as they move in the same direction but in a different range.

How to trade on currency pair correlations in forex?

Currency correlations can be traded in forex by identifying all currency pairs that have a positive, negative and no correlation to one another.

When you identify two or more currency pairs having a positive correlation, you can open the same position in all of them.
When you identify currency pairs with a negative correlation, you open two opposite positions.
Identifying currency pairs with no correlation gives you a free hand in opening a long or short order as per your preference.

When you open two long positions in a positively correlated currency pair, the separate positions help you increase your profits as they move in your favour. However, opening the same long or short position in two currency pairs that are negatively correlated to each other cancels each other out as when one moves in your favour reaping you profits, the other moves against you, cancelling those profits. That is why it is recommended to always open opposing positions in negatively correlated currency pairs. You can open different positions in correlated currency pairs to diversify your forex portfolio and protect yourself against market risks. When a single currency pair moves against you, having positions in correlated pairs helps you either cancel out the losses or actually profit from the opposite movement. For example, assuming that you are trading USD/CHF and EUR/USD together that are negatively correlated to each other. You open a long position worth 10 euros in EUR/USD and simultaneously open a short position worth 8 euros in USD/CHF. If EUR/USD falls to 2 euros, you make a loss of 8 euros in total. However, the fall in EUR/USD results in the increasing price of USD/ CHF, which rises to 15 euros. This reaps you a total profit of 7 euros. Hence, opening two opposite positions in the negatively correlated currency pair actually results in you making a loss of only 1 euro, which would not have been possible had you not traded correlated currency pairs.

What are the most highly correlated currency pairs?

EUR/USD vs GBP/USD

EUR/USD vs GBP/USD has a very strong positive correlation that ranges between and (81% to 95%), implying that any increase in EUR/USD will definitely lead to an increase in GBP/USD exchange rates as well and vice versa. These two currency pairs are highly correlated because there is a very close relationship between the UK’s GBP and the European currency Euro. They are both one of the most vastly held reserve currencies, and their close geographic proximity and strong trade relations affect their economies almost the same way.

GBP/USD vs EUR/JPY

GBP/USD vs EUR/JPY has a strong positive correlation that ranges between to (88% to 94%). The positive correlation between the two pairs stands due to the already discussed positive correlation between GBP and EUR, along with the strong and close trade relationship between Japan (JPY) and America (USD). Japan is also one of America’s closest and oldest allies, and the countries view each other favourably.

EUR/JPY vs USD/JPY

EUR/JPY vs USD/JPY also has a positive, strong correlation that ranges between and (86% to 98%). This positive correlation exists between these two currency pairs due to their strong political relations and alliance between them. Europe and America are also one of the biggest economies in the world, having strong economic relations with dominating military power, making the two economies positively correlate to each other as a decision by one economy is usually followed by the other.

AUD/USD vs NZD/USD

AUD/USD vs NZD/USD is the last most highly and positively correlated pair that ranges between and (86% to 99%). They are highly and positively correlated because Australia and New Zealand hold one of the strongest ally relationships with each other in the world economy. Not only are they in close geographical proximity, their trade, defence, and migration ties are strong, making them positively correlated. The two countries also have a very strong people-to-people link, making the relationship between the two countries and their currencies powerful.

EUR/USD vs USD/CHF

EUR/USD vs USD/CHF is one of the most highly and negatively correlated currency pairs that ranges between to -1 (% to %), implying that any increase in EUR/USD will definitely lead to a decrease in USD/CHF’s currency exchange rate and vice versa. The two pairs are negatively correlated mainly because of Europe's divergent monetary and political policies as a whole and Switzerland as an independent country. In most cases, any uncertainty affecting Europe does not have a considerable impact on Switzerland and vice versa due to the different processes and procedures followed by both regions.

EUR/USD vs USD/CAD

EUR/USD vs USD/CAD is also strongly and negatively correlated between and (% and 98%). They are negatively correlated due to the USD being a quote currency in the first pair and a base currency in the second pair. Since Europe and Canada have a very strong, friendly and strategic relationship with each other, any increase in USD’s price decreases EUR/USD but increases USD/CAD as more Euro is then required to purchase a single unit of USD, but less Canadian dollars are needed for the same.

AUD/USD vs USD/CHF

AUD/USD vs USD/CHF is the last highly inversely correlated pair that ranges between to (% to %). The inverse relation between the two pairs is due to the US currency being in the quote currency place in the first currency pair and in the base currency place in the second one. Hence, any positive movement in the USD marks a negative movement in AUD/USD but a positive movement in USD/CHF. This inverse relationship is also affected due to the positive economic and political relations shared by Switzerland and Australia, along with their strong diplomatic relations.

Can commodities be correlated with currencies?

The currency pairs are not only correlated with each other but with several commodities like oil, gold and more. Currencies are correlated with commodity trading when a particular country is a prominent net exporter or importer of the commodity. Any change in that currency’s exchange rate or commodity prices affects one another. One of the highest correlated currencies with commodities are the Australian Dollar, the US Dollar, the Swiss Franc, the Canadian Dollar, the Japanese Yen and the Euro.

The Australian Dollar is strongly and positively correlated with the prices of precious metals like gold, copper and silver since Australia is one of the highest producers of these metals.
The US dollar is inversely correlated with most commodities, especially oil since all commodities are quoted in the US dollar. Hence, when the US dollar is strong, one needs a lesser amount of the US dollars to buy the commodity and vice versa.
The Swiss Franc has a strong positive correlation with gold since 1/4th of Switzerland’s total money supply is guaranteed through gold reserves.
Since Canada is one of the biggest net exporters of oil, it holds a strong positive correlation with the commodity.
Japan is one of the biggest net importers of oil and hence has a strong inverse correlation with the commodity.
As Euro is the closest alternative to the USD and the second-largest traded currency after the US dollar, it holds a positive correlation with oil and precious metals like gold.

Currency correlation formula

R = Σ (X- x̄) (Y- Ȳ) / under root of (Σ [(X- x̄)(X- x̄)]) * under root of (Σ [(Y- x Ȳ)(Y- Ȳ)]) Where, R = correlation coefficient X = first currency in the currency pair Y = second currency in the currency pair x̄ = average of all the variable X observations Ȳ = average of all the variable Y observations

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Currency correlations or forex correlations are a statistical measure of the extent that currency pairs are related in value and will move together. If two currency pairs go up at the same time, this represents a positive correlation, while if one appreciates and the other depreciates, this is a negative correlation.

Understanding and monitoring currency correlations is important for traders because it can affect their level of risk when trading in the forex market. In this article, we will look at how forex correlation is determined and calculated, how it affects trades and trading systems, and what tools can be used to track currency correlations.

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What is correlation in forex trading?

A foreign exchange correlation is the connection between two currency pairs. There is a positive correlation when two pairs move in the same direction, a negative correlation when they move in opposite directions, and no correlation if the pairs move randomly with no detectable relationship. A negative correlation can also be called an inverse correlation.

Currency correlation is important for traders to understand because it can have a direct impact on forex trading results, often without the trader’s awareness.

As an example, assume that a trader buys two different currency pairs that are negatively correlated. The gains in one may be offset by losses in the other, which is often used as a hedging strategy. Meanwhile, buying two correlated pairs may double the risk and profit potential, since both trades will result in a loss or profit. They are not fully independent since the pairs move in the same direction.

What is the correlation coefficient?

A correlation coefficient represents how strong or weak a correlation is between two forex pairs. Correlation coefficients are expressed in values and can range from to , or -1 to 1, with the decimal representing the coefficient.

Anything in the negative range of means that the pairs move nearly identically but in opposite directions, whereas, if it is above , it means that the pairs move nearly identically in the same direction. “Nearly identically” is an important distinction to make because correlation only looks at direction but not magnitude. For example, one pair may move up pips (percentages in point) while another moves down 70 pips. Both pairs may have a very high inverse correlation, even though the size of the movement is different.

If a reading is below and above 70, it is considered to have strong correlation, as the movements of one are largely reflected in movements of the other. Readings anywhere between and 70, on the other hand, mean that the pairs are less correlated. With forex correlation coefficients near the zero mark, both pairs are showing little or no detectable relationship with one another.

Correlation coefficient formula

While this formula looks complicated, the general concept is that it is taking data points from two pairs, x and y, and then comparing them to average readings within these pairs. The top part of the equation is the covariance and the bottom part is the standard deviation.

For example, think of the data points as closing prices for each day or hour. The closing price of x (and y) is compared to the average closing price of x (and y), so a trader can enter closing and averaged values into the formula to extract how the pairs move together. To get the average requires tracking multiple closing prices in a program such as Microsoft’s Excel spreadsheet. Once multiple closing prices have been recorded, an average can be determined, which is continually updated as new prices come in. This is plugged into the formula along with new values for x.

Forex correlation pairs

The following table shows the correlation between some of the most traded currency pairs across the world. You can compare each currency on the y-axis to those on the x-axis to see how they are correlated to one another. For instance, the correlation between the EUR/USD and GBP/USD is 77, which is quite high.

EUR/USD	GBP/USD	AUD/USD	GBP/JPY	EUR/JPY	EUR/GBP	USD/JPY	USD/CHF	USD/CAD
EUR/USD	77	75	66	50
GBP/USD	77	70	88	19
AUD/USD	75	70	60	31
GBP/JPY	66	88	60	54		-9
EUR/JPY	50	19	31	54	7	54
EUR/GBP					7	49	30	68
USD/JPY				-9	54	49	57	45
USD/CHF						30	57	70
USD/CAD						68	45	70

While the pairs won’t always move in exactly the same direction, they do move mostly together. In comparison, the GBP/USD and EUR/GBP have a strong negative correlation at , meaning they move in opposite directions much of the time.

Monitoring currency correlations is important because, even in this small table of currency pairs, there are several strong correlations. A trader could unwittingly buy the GBP/USD and sell the EUR/GBP thinking that they have two different positions, for example. 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.

Examples of currency correlation

Forex correlation hedging strategy

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. This may be useful if a trader doesn’t want to exit a position but wants to offset or reduce their loss while the pair pulls back.

For example, the EUR/USD and AUD/USD share a strong positive correlation in the table above at Buying the EUR/USD and selling the AUD/USD creates a partial hedge. It is partial because the correlation is only 75 and correlation doesn’t account for magnitude of price movements, only direction.

In the case of the GBP/USD and EUR/GBP, there is a negative correlation. Therefore, buying or selling both creates a hedge. Buying the GBP/USD will make money if the GBP/USD goes up, but those gains will be offset by the long position on EUR/GBP falling because of the negative correlation.

Read more about forex hedging strategies.

Commodity currency correlation

Commodities or raw materials also have a correlation with each other as well as with currencies. In the table below, the data shows that during this timeframe, gold (XAU/USD) had little correlation with other major currencies. However, it does indicate that it shared a strong positive correlation of 81 with silver (XAG/USD). For someone trading gold and holding positions in other currency pairs, this type of analysis is important.

EUR/USD	GBP/USD	XAG/USD	WTICO	CAD/JPY	NATGAS	XAU/USD	USD/JPY	USD/CAD
EUR/USD	77	54	50	47	24	19
GBP/USD	77	17	42	46	58
XAG/USD	54	17	11	24	-6	81
WTICO	50	42	11	54			7
CAD/JPY	47	46	24	54	18	2	31
NATGAS	24	58	-6		18
XAU/USD	19		81		2		-6	-6
USD/JPY				7	31		-6	45
USD/CAD							-6	45

Commodity correlation table

For example, it is worth noting that natural gas doesn’t share a high correlation with any currency pairs, or with precious metals like gold or silver. Meanwhile, crude oil (WTICO) also doesn’t show a high correlation to currencies, but it often does have a correlation with the USD/CAD and CAD/JPY. 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.

Pairs 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.

However, there is a danger that the pairs don’t go back to being highly correlated. Therefore, some traders may place a stop-loss order on each position to control the loss. There is also a danger that the loss on one trade isn’t offset by a gain on the other, resulting in a loss, even if the pairs move back to their previous correlation. 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. For instance, if the stop loss is 30 pips in the EUR/USD (with a USD account), taking a micro lot position means there is a risk of $3 on the trade (30 x $). For that $3 of risk to be equal to only 1% of the account, the trader would need to have at least $ in the account. This way, the risk on the trade and risk to the account is controlled.

What do non-correlated forex pairs mean?

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.

For example, the EUR/USD and GBP/USD both contain the US dollar, and the Eurozone and Great Britain are in close proximity with closely tied 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. Meanwhile, the EUR/JPY and AUD/USD have no matching currencies. In fact, the Eurozone, Japan, Australia and the US all have distinct and separate economies. Therefore, the correlation between these pairs tends to be lower.

How to trade forex correlation pairs

There are many ways that correlations can be used as part of a forex trading strategy, such as through hedging, pairs trading and commodity correlations. To start trading forex correlations pairs, all you need to do is the follow the below steps:

Open a live account. Alternatively, you can practise with virtual funds on our demo trading account.
Research the forex market. Improve your knowledge of currency pairs and what affects them, such as inflation, interest rates and other economic data.
Pick a currency correlation strategy. It is often a good idea to build a trading plan beforehand.
Explore our risk management tools, such as stop-loss and take-profit orders, which can be useful for managing risk in volatile markets. Remember that these do not always protect you from market gapping or slippage.
Place your trade. Decide whether to buy or sell and determine entry and exit points.

Forex correlation trading system

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. Next Generation is an award-winning forex trading platform* that allows you to view and trade forex correlations in real time.

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. The following chart compares the EUR/USD (candlestick) with the GBP/USD (line). These pairs typically move together, but in this example, they moved in opposite directions. This set up is a potential mean-reversion trade.

Currency correlation indicator for MT4

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. You can filter indicators by name, so typing in “correlation” in the Code Base section will often find relevant add-ons for the system. These can be installed to the MT4 platform easily. Open an MT4 account now to get started.

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Hedge Ratio: Definition, Calculation, and Types of Ratios

What Is the Hedge Ratio?

The hedge ratio compares the value of a position protected through the use of a hedge with the size of the entire position itself. A hedge ratio may also be a comparison of the value of futures contracts purchased or sold to the value of the cash commodity being hedged.

Futures contracts are essentially investment vehicles that let the investor lock in a price for a physical asset at some point in the future.

The hedge ratio is the hedged position divided by the total position.

How the Hedge Ratio Works

Imagine you are holding $10, in foreign equity, which exposes you to currency risk. You could enter into a hedge to protect against losses in this position, which can be constructed through a variety of positions to take an offsetting position to the foreign equity investment.

If you hedge $5, worth of the equity with a currency position, your hedge ratio is ($5, / $10,). This means that 50% of your foreign equity investment is sheltered from currency risk.

Types of Hedge Ratio

The minimum variance hedge ratio is important when cross-hedging, which aims to minimize the variance of the position's value. The minimum variance hedge ratio, or optimal hedge ratio, is an important factor in determining the optimal number of futures contracts to purchase to hedge a position.

It is calculated as the product of the correlation coefficient between the changes in the spot and futures prices and the ratio of the standard deviation of the changes in the spot price to the standard deviation of the futures price. After calculating the optimal hedge ratio, the optimal number of contracts needed to hedge a position is calculated by dividing the product of the optimal hedge ratio and the units of the position being hedged by the size of one futures contract.

Key Takeaways

The hedge ratio compares the amount of a position that is hedged to the entire position.
The minimum variance hedge ratio helps determine the optimal number of options contracts needed to hedge a position.
The minimum variance hedge ratio is important in cross-hedging, which aims to minimize the variance of a position's value.

Example of the Hedge Ratio

Assume that an airline company fears that the price of jet fuel will rise after the crude oil market has been trading at depressed levels. The airline company expects to purchase 15 million gallons of jet fuel over the next year, and wishes to hedge its purchase price. Assume that the correlation between crude oil futures and the spot price of jet fuel is , which is a high degree of correlation.

Further assume the standard deviation of crude oil futures and spot jet fuel price is 6% and 3%, respectively. Therefore, the minimum variance hedge ratio is , or ( * (3% / 6%)). The NYMEX Western Texas Intermediate (WTI) crude oil futures contract has a contract size of 1, barrels or 42, gallons. The optimal number of contracts is calculated to be contracts, or ( * 15 million) / 42, Therefore, the airline company would purchase NYMEX WTI crude oil futures contracts.

Playing on forex correlation

Fears of a sovereign default in the eurozone have eased recently, but rewind to May and things were looking pretty dicey. The Greek debt crisis was spiralling and there were signs of contagion in other peripheral European states. Wild scenarios started doing the rounds: a Greek debt restructuring, the forcible expulsion of Greece from the eurozone, a voluntary withdrawal of Germany from the euro. In a world terrified of black swans, risk managers began to look for macro hedges from the end of

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KEY POINTS

Forex pairs can move together in a positive or negative correlation
The correlation coefficient formula represents how strong or weak their connection
A reading below and above 70 is considered strong, whereas a readings between and 70 is considered weaker
Traders may choose to hedge their positions by purchasing negatively correlated forex pairs, hoping that the gains in one may be offset by losses in the other
Commodities may also have a correlation with each other, as well as with forex

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What is correlation in forex trading?

Currency correlation is important for traders to understand because it can have a direct impact on forex trading results, often without the trader’s awareness.

What is the correlation coefficient?

Correlation coefficient formula

Forex correlation pairs

What are some examples of currency correlation?

Forex correlation hedging strategy

Read more about forex hedging strategies.

Pairs trading

Commodity currency correlation

Is it possible to trade for a living?

It is possible to make money trading, but it comes with many risks and extra costs that must be taken into consideration. Consult our section on ‘what else do you need to know’ before opening a potentially risky trade. After all, not all positions will end in profit.

To see whether you could make money from spread betting or trading CFDs, you could try out our risk-free demo account, which allows you to practise first using £10, of virtual funds. Once you feel confident enough to enter the live markets using real funds, you can then switch to a live account.

What do non-correlated forex pairs mean?

How to trade correlation

There are many ways that correlations can be used as part of a forex trading strategy, such as through hedging, pairs trading and commodity correlations. To get started, follow the steps below.

Choose your product. Forex is often traded through derivatives such as spread betting or CFDs, so read about the differences between them.
Research the forex market. Improve your knowledge of currency pairs and what affects them, such as inflation, interest rates and other economic data.
Pick a strategy. It is often a good idea to build a trading plan beforehand.
Explore risk-management tools. For example, stop-loss and take-profit orders can be useful for managing risk in volatile markets, although these do not always protect you from market gapping or slippage.
Place your trade and monitor. Decide whether to buy or sell and determine entry and exit points, keeping an eye out for profit or loss.

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What else do you need to know before trading?

Trading on the financial markets can be a daunting process, especially for a beginner, so it may be a good idea to brush up your knowledge on the following things beforehand:

Costs (including spreads, margin rates, overnight fees, commissions)
The risk that your chosen market or instrument presents
How trading with leverage works (also known as trading on margin)
How to prevent margin calls and account close-outs
Risk-management tools, indicators and market data that can help with every trade

Getting started on our forex correlation trading system

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. Next Generation is an award-winning web trading platform* that allows you to view and trade forex correlations in real time.

So, have you finished reading this article and want to get started spread betting or trading CFDs on our platform? Follow the simple steps below to sign up for an account.

Open a trading account to access our product library. You’ll be able to practise first using £10, of virtual funds on our risk-free demo account.
With a demo, you can access financial markets such as commodities, forex, indices and treasuries for an unlimited period of time, as well as one-month free access to shares and ETFs.
Deposit funds to open your live account and access unlimited instruments. Your subscription will also include exclusive market data, Morningstar reports and a Reuters news feed.

Currency correlation indicator for MT4

There is no default currency correlation indicator on the MT4 trading platform; 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. You can filter indicators by name, so typing in “correlation” in the Code Base section will often find relevant add-ons for the system. These can be installed to the MT4 platform easily.

Open an MT4 account now to get started.

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Currency pair correlations — Forex trading

Understanding price relationships between various currency pairs allows you to get a more in-depth look at how to develop high-probability Forex trading strategies. Awareness of currency correlation can help to reduce risk, improve hedging, and diversify trading instruments. In this article, we will introduce you to Forex trading using intermarket correlations.

Meaning of currency pairs correlation in Forex

Correlation is a statistical measure of the relationship between two trading assets. Currency correlation shows the extent to which two currency pairs have moved in the same, opposite, or completely random directions within a particular period.

Currency correlation

Analysis of two asset relationships using past statistical data has predictive value. By utilising the correlation coefficient, we can understand the relationship between two values and help manage risk. The coefficient is measured in decimal form from -1 to +1.

A correlation of +1 shows that two currency pairs will move in the same direction % of the time. That is a perfect positive correlation. The correlation between EUR/USD and GBP/USD is a good example—if EUR/USD is trading up, then GBP/USD will also move in the same direction.
A correlation of -1 indicates that two currency pairs will move in the opposite direction % of the time. EUR/USD and USD/CHF have a perfect negative correlation, thus if EUR/USD moves upwards, then USD/CHF goes downwards.
A correlation of zero takes place if the relationship between currency pairs is completely random, which means they have no link at all.

Naturally, the stronger a positive or negative correlation, the higher a predictive value is drawn from the analysis. More extended time frames used for a technical analysis display more precise information compared to relationships over one minute, which have a little value. Monthly and yearly data generally provide the most reliable insight.

Impact of currency correlations on Forex trading

They can form a basis of a statistically high probability Forex trading strategy.
They can illustrate the amount of risk you are exposed to within your Forex trading account. For example, if you have bought several currency pairs with a strong positive correlation, then you are exposed to higher directional risk.
You can avoid positions that effectively cancel each other out. EUR/USD and USD/CHF have a powerful negative correlation. If you have a directional bias, buying both EUR/USD and USD/CHF will counteract the moves in each pair.
Understanding correlations can allow you to hedge or diversify your exposure to the Forex market.
If you have a directional bias for a given currency, you can spread your risk using two strongly positive correlated pairs, in terms of diversification.
If you are looking to hedge a position (holding it with low risk of losses) you can take a position in a negatively correlated pair. If you were to initiate a ‘long buy’ for EUR/USD, and it begins to move in an unfavourable direction, you can then hedge your position by purchasing a currency pair that has a negative correlation to EUR/USD, like USD/CHF.

Forex Trading strategies based on correlation

When two pairs are highly correlated, one can serve as a leading indicator of the price movement of the other. If you see a sharp move in one of the two positively correlated pairs, you can anticipate a probable move in the other.

lagging

Correlation can be even a more powerful Forex tool for analysis in conjunction with other Forex indicators. For instance, if one pair breaks out above or below a significant technical level of support or resistance, the closely positively correlated pair has a high probability of the following risk.
If you notice two negatively correlated currency pairs and a significant upward price reversal in one pair takes place, then you can anticipate a potential downward reversal in the other pair. This is a price reversal.
Wait for an abnormal divergence between two highly correlated currency pairs and buy one and sell the other, with the expectation that they will converge in price movement again. This is a non-directional arbitrage exploiting currency correlations.

positive correlation

Highly correlated currency pairs in Forex

Examples of strong positive correlations (Yearly time frame):

EUR/USD and GBP/USD (+ )

EUR/USD and AUD/USD (+ )

EUR/USD and EUR/CHF (+ )

AUD/USD and Gold (+ )

Examples of strong negative correlations (Yearly time frame):

EUR/USD and USD/CHF (- )

USD/CAD and AUD/USD (- )

AUD/NZD and NZD/SGD (- )

USD/JPY and Gold (- )

Commodities that are correlated with currencies

The Canadian dollar and crude oil have a positive correlation because Canada is a significant oil producer and exporter.
Similarly, the Australian dollar and gold have a positive correlation because Australia is a significant gold producer and exporter. Both gold and the Japanese Yen are viewed as safe havens in times of uncertainty, and these two are also positively correlated.

negative divergence

Meanwhile, gold and the U.S. dollar typically have a negative correlation.
When the U.S. dollar starts to lose its value amid rising inflation, investors seek alternative stores of value such as gold.

divergence

Currency correlations change in Forex

Be aware that currency correlations are continually changing over time due to various economic and political factors. These often include diverging monetary policies, commodity prices, changes in central banks’ policies, and more. Given that strong correlations can change over time, it highlights the importance of staying up to date in shifting currency relationships. We recommend checking long-term correlations to acquire a more in-depth perspective.

All in all, currency correlations could be a powerful tool you can use to develop high-probability trading strategies. You'll also be aided in risk management, mainly if you track the correlation coefficients over daily, weekly, monthly and yearly timeframes.

In forex trading, currency movement tells a lot about the market condition. It allows traders to know whether they should open or close a trading position. This means understanding forex correlation pairs is crucial as it helps you see the level of risk in the market.

When you understand how to use correlated pairs and how they affect the market, trading will be easier for you.

Unfortunately, most traders still find it hard to understand them. This is why this article is here to help you understand forex pair correlation, how to trade using them, and the best tips to use while dealing with correlated forex pairs.

What Does Correlation Mean In Forex Trading Pairs?

Correlation in forex trading means a connection between two currency pairs. There are usually two types of currency correlation; positive correlation pairs and negative correlation pairs. The positive correlation means that two forex pairs are moving in the same direction.

On the other hand, a negative correlation means that two pairs are moving in the opposite direction. They are also known as inverse correlation pairs.

Forex pairs correlation is usually important to traders because they might affect trades without a trader’s knowledge. This is why traders follow them keenly to maximize their profits and find forex hedging opportunities. If you know a particular forex pair will move against each other, you can open both positions to maximize your profits.

However, you must be very keen when using currency correlations. If you miss-predict the market, you might incur huge losses. Your hedging will also not be very effective as you had thought it would be.

Understanding Correlation Coefficient in Forex Currency Pairs

Correlation is usually computed into a correlation coefficient. This represents how weak or strong two forex pairs are. They are expressed in numbers or values that range from -1 to 1 or to

A positive correlation of +1 means that two currency pairs will identically move in the same direction. While a negative correlation of -1 means that the two forex pairs will identically move against each other.

Reading charts and currency pairs correlation table is also crucial as it helps understand how correlation functions. A reading that is less than and more than 70 means a strong correlation.

On the other hand, if a reading ranges in and 70, it means that currency pairs are not strong or less correlated. The formula below explains well how the correlation coefficient is calculated.

The Most Correlated Forex Currency Pairs

In this section, we will look at both the forex pairs that move together (Positive correlation) and those that move against each other (Negative correlation).

Apart from that, you will also understand why the pairs are considered positive and negative and how you can use them when trading.

Positive Correlated Forex Currency Pairs

Highly positive correlated pairs are considered to have the same economic ties. They include;

EUR/USD and GBP/USD

This is one of the many forex pairs that correlate. The forex pairs increase and decrease are often viewed as equals. They correlate so well because of their relationship with the US dollar, the pound, and the Euro. All three currencies are intertwined by their strong economic ties.

When trading with this two currency pair correlation, you can open two long positions since both currencies move in the same direction. If both the EUR/USD and GBP/USD increase in price, you can potentially make better profits with the two forex correlated pairs.

Alternatively, you can go short if you predict one currency pair will fall earlier than the other. If one fails, most likely, the other will follow alongside the previous currency pair.

Other Positive Correlated Pairs

EUR/USD and AUD/USD
USD/CHF and USD/JPY
AUD/USD and NZD/USD
EUR/USD and NZD/USD

Negative Correlated Forex Currency Pairs

These are pairs that usually take the opposite direction. One familiar pair is;

EUR/USD and USD/CHF

When it comes to this forex currency pair correlation, the USD/CHF usually moves against the EUR/USD. Its negative correlation ranges below and sometimes goes further below Effective traders typically take advantage of this negative correlation and hedge in one of the present pairs.

A good example is when you go long on both the EUR/USD and USD/CHF, despite their negative correlation. This helps protect you against the short-term volatility that may occur in the market. Again, any gains in the long position will offset the losses that might happen in the other opposite currency.

Other negative correlated pairs

GBP/USD and USD/CHF
USD/CAD and AUD/JPY
USD/JPY and AUD/USD
GBP/USD and USD/JPY

How To trade Correlated Forex Currency Pairs

Forex correlation pairs offer a lot of trading advantages. Wise traders can use them to hedge and in commodity correlations. All you need to do is differentiate the positively correlated pair and negatively correlated pairs before using them in your trade.

The following steps will help you trade confidently using correlated pairs;

Find a Trading Platform and Open a Live Account. The first thing you need to do to trade with correlated pairs is to get a live trading account. You can use your preferred trading platform. Alternatively, you can begin with a demo account to understand how they work before using a live account.
Do Your Research on Forex Pairs. There are several forex pairs, which can sometimes be confusing, especially if you are a beginner. Do your research and make a correlated forex pair list to know which ones are highly correlated. Also, try to find out what affects them and how you can use that to your advantage.
Choose the Best Correlation Strategy. Building a trading plan before proceeding is a wise thing to do. The good news is that there are so many strategies to use in forex. Find or build one that favors your trading and stick to it while finding other better methods to grow your profits.
Take Advantage of Risk Management Tools. With risk management tools, you can easily avoid loopholes while trading. It helps you manage the risk that comes with high market volatility or sudden price changes. Seek advice from professional traders to know the best risk management tools to use when dealing with forex currency pair correlation.
Open a Trading Position. After figuring out the above things, place your trades. You can either sell or buy, depending on the current market condition. Remember to use indicators as they help a lot in signaling entry and exit positions.

Should I trade correlated pairs?
Yes, you can trade with correlated pairs so long as you understand how they work. Also, you can practice using them before switching to live accounts.
Can I make good profits with correlated forex pairs?
You can make better profits with correlated pairs if you apply them appropriately.
Are there any forex pairs that correlate with commodities?
Forex pairs do not only correlate with other pairs. They also correlate with commodities such as gold, crude oil, etc.

Matthew is the Head of Operations at AudaCity Capital. He graduated from The University of Hertfordshire with a distinction in Finance and Investment Banking (MSc) and has dedicated his post graduate life to the FX markets.

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