Forex Correlation – Tables and Trading Strategies

Trading on the relationship between currencies on Forex Strategies and Examples, as well as calculation features and additional services. How to earn money from the currency pair correlation.

Between several assets there is a positive or negative feedback relationship, this phenomenon is known as the correlation phenomenon in Forex. The idea of a relationship between the actions that two instruments could be utilized for trading, and sometimes allows for a better prediction of the performance of charts in the near future. The relationship between currencies with Forex is not a new concept it has been utilized by traders for over an entire year. It is safe to be sure that this strategy has been tried and tested in practice.

Below is a comprehensive description of the phenomenon, some suggestions for working on it, as well as an example of a pair-correlation strategy.

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What is the relationship between Forex?

The definition of a correlation refers to the relationship between at most two different things. In the financial market, it is such things as quotes of currencies or prices for stocks. This phenomenon isn’t only restricted to financial markets there is an inverse relationship in the everyday world like the frequency of visits to emergency rooms is correlated with the season. In countries with a warm climate, there are more calls to the emergency room than in the summertime.

A Forex correlation is a straight or inverse relationship between two currencies. These dependencies arise because of the unique characteristics of trading. For instance, in times that see a rapid increase in the demand for the US dollar the positive correlation increases in the relationship between EURUSD as well as GBPUSD. Because of the increased demand for the US dollar, it is evident that the American dollar is becoming more expensive, and chart charts for both currencies are in the same direction.

The currency that is listed In the same scenario the opposite correlation could be observed. If investors invest in USD, you will see an inverted relationship between EURUSD and USDJPY which means that EURUSD is rising, and USDJPY is declining.

The basic definition of forex correlation is the degree of feedback or direct interaction between currencies. The precise number that indicates this relationship does not matter but it is essential to determine the strength of this connection. This type of phenomenon can be used to determine the general market’s mood.

Correlations in different forms Forex

It is possible to classify it in accordance with a number of factors. If we consider the direction of asset movement We can differentiate:

  1. Direct connection In the example that follows, EURUSD and GBPUSD move in the same direction as demand for dollars rises. This is a classic illustration of a direct correlation.
  2. Reverse. One instrument is increasing, while the other is declining simultaneously.

Based on the nature of the relationship between assets, one can differentiate:

A random or unstable connection. It’s created without essential prerequisites and can be formed without. In some areas of history, there is a possibility that a link can be created between any asset, like that in the case of USDMXN ( US dollar and Mexican peso ) rate and wheat quotes. What is the basis of the connection is determined by studying it over a long period. The unpredictable nature of the relationship is evident by a constant shift in the sign, and the movement close to zero or chaotic jerks that span the range of -1 to +1.

  • steady correlation. This is caused by fundamental causes and lasts for a long distance. One example of these dependencies is the oil price along with the USDCAD rate. USDCAD rates, as well as the relationship with EURUSD and USDCHF and the effect of oil prices on ruble pairs.

The division based on the degree of connection between the assets may be arbitrary and the values are only to give informational purposes. In the trading industry generally there is only a solid connection between Forex instruments used in market trading is utilized.

For the optimal correlation, it should not be greater than 1.0 or 100 percent. In actuality, it doesn’t happen, for example, between S&P 500 and SPY ETF (copies the index basket) The correlation can be anywhere from 95 to 99 percent . For Forex instruments, numbers within the range 70-90 percent are a reliable indicator.

How do you spot the signs of a correlation?

Manual calculations are not necessary the calculator calculates your coefficient for you automatically. Below is a listing of information and analytical services that are available online with calculators for correlating:

Mataf.net is – Very informative service. It displays a graphic representation of the changes in correlation over time. Many more tools are also supported. The data is presented in a table format to make it easier both inverse and direct correlations are displayed with different shades of red and green. Due to this, a cursory glance is sufficient to identify instruments with maximum feed-forward/feedback.

MyFxBook.com – A characteristic that this application offers is the capability to filter results based on the degree of relationship. In other words, it is an ordinary table that displays the relationship between the assets in percentage. The relationship between only two assets is shown, however, the correlation with 11 different pairs of instruments may be compared. The comparison is displayed in graphic form. You may also select the time frame for which calculations are made.

Oanda.com – In addition to the currency pairs, metals and stocks are also displayed. The results are displayed as a standard table as well as the temperature map (the more saturated the hue, the more significant it is the relationship) and the bubble chart. In the last scenario, a stronger relationship between the instruments equates to circles with a larger diameter.

You are able to utilize any of the services listed.

Manual calculation and use of indicators to determine the correlation

The manual calculation can be facilitated by using Excel and the CORREL function. In a tabular form, you can specify an array of values ​​of random variables and use CORREL to calculate the correlation value between them. This method is not used in trading, as there are both online services and indicators that calculate the correlation value in real-time.

TradingView

There are such tools for the MT4, and MT5 terminals, and for the live chart from TradingView. To quickly assess the correlation, you can use the Correlation Coefficient indicator for currency pairs. In the settings, you need to specify what exactly the asset will be compared with, the depth of history at which the calculation is performed and the price used.

The so-called moving correlation is calculated, that is, its value is updated on each new candle. In the example, on each new candle, the value of the connection between EURUSD and USDCHF is calculated for a segment of the last 20 candles.

One of the assistants in this will be the indicator of the correlation of currency pairs. Most Popular:

  1. OVERLAY CHART – the principle of operation is that with the help of this program, two charts are displayed in the trading terminal at once in one window. This will allow the trader to see the dependence of the instruments in real-time. The indicator has few settings, so even a beginner can figure it out.
  2. CORRELATION TABLE is a more informative, but less understandable indicator for a beginner. All calculations are displayed at the bottom of the terminal in digital form. If the dependence of the pairs is strong enough, then the numbers are additionally circled in color. You can choose a large number of pairs, and follow them all at once.
  3. CORRELATION is a simple tool that displays correlation information as lines. Additionally, the numerical value of the dependence is also indicated.

How to trade on correlations

как заработать на корреляции валютных пар

The following are the main trading techniques using the connection between 2 assets:

  • Leading movement . 2 instruments are selected with a guaranteed high direct/feedback, a slave and a leading asset are determined, transactions are opened on a slave instrument based on signals from the master. You can use, for example, graphical analysis, both pairs can simultaneously be in the region of an important level, on one of them the breakdown occurs earlier. It is possible to enter the market on a led pair at a better price.
  • Simultaneous trading on both pairs. This maximizes the risk, but the probability of doubling income also increases, and both forecasts may well work out.
  • Trading divergences between highly correlated assets. The strategy is more suitable for automated trading. Tools with high feedforward/feedback rarely diverge for a long time, manually catching such moments is difficult, robots do a better job of this task. This style of trading requires a stable connection above 80%, preferably above 85%, an example of such a pair of assets is AUDUSD and AUDJPY. This trading on the correlation of currency pairs is called statistical arbitrage and is classified as risk-free. Earnings on arbitration does not depend on the direction of movement of currency pairs.
  • Risk hedging . This issue will be discussed in more detail below.

Also, the relationship between 2 assets can be used as a filter when opening new positions or taking profits.

Hedging correlation

Hedging refers to risk reduction. The phenomenon of connection between 2 instruments is also used in this case, hedging is used in both trading and investing.

In trading, risk reduction comes down to opening an opposite position on a currency pair that correlates with the one on which the transaction has already been opened. Examples include EURUSD and USDCHF with high feedback. If a long position is opened, for example, in EURUSD, then to reduce the risk, you can open a counter position in USDCHF.

Buying on EURUSD means that the bet is made on the fall of the dollar. Hedging means buying USDCHF – a bet on the strengthening of the US national currency.

The investor acts in a similar way, but other instruments are used for hedging. If the portfolio is represented by the S&P 500 index, ETF shares with the ticker SPY are bought, then in order to hedge, you need to take a short position in the same instrument. To do this, it is enough to buy securities of a bearish ETF, its quotes grow when the S&P 500 falls and vice versa. This is usually done on the eve of the expected crisis, the income from the shorting ETF compensates for the drawdown in the main investment portfolio.

Индекс и ETF

This example also used the phenomenon of correlation. There is almost a 100% inverse relationship between regular and bearish ETFs, so a short ETF is ideal as a hedging tool.

Strategies

An excellent example of this type of TS is the Yen Trader system (Cross Trader after modification). The analysis involves 3 currency pairs, the third should be formed from the first two. For this TS, both currency pairs with inverse correlation and instruments with direct connection are suitable.

If GBPUSD and USDJPY pairs are selected for work, then the third should be GBPUSD x USDJPY = GBPJPY. For two majors, the conditions for entering the market are checked, and for GBPJPY, the market is entered directly.

The essence of the strategy :

  • With the simultaneous growth of the GBPUSD and USDJPY majors, the pound strengthens and the Japanese national currency falls. If USDJPY moves up, it means that more Japanese yens are given for 1 dollar, that is, the trend for the yen is down.
  • If this condition is met, it is highly likely that the yen will also fall in pair with the pound, that is, you can open a long position on GBPJPY. For transactions to sell, the conditions are reversed.

The strategy uses the phenomenon of correlation, but does not evaluate the strength of the connection between currency pairs. Also in the basic rules there are no rules for setting stops, take profits. That is, this is not a ready-made strategy, but rather a preparation for it, there is a core, but the details will have to be thought out on your own.

Work can be carried out on H1, H4 and D1 timeframes. When working on a four-hour chart, the closing price is compared to the Close prices of the week before. If the closing price of the current candle is higher than the previous week, the pair is considered to be rising. For purchases, this condition must be met simultaneously on both GBPUSD and USDJPY. As soon as this happens, a buy position on GBPJPY is immediately opened.

If the work is carried out on an hourly chart, then the prices for the previous day are compared. If on a daily timeframe, then for a month.

It is important that the condition is fulfilled simultaneously for both currency pairs.

It is critically important to set the stop loss correctly. In the example of working out a bullish signal for GBPJPY, it was possible to take a profit, but only if the stop was set with a margin.

The disadvantage of strategies of this kind is too rare signals. In addition, the details have not been worked out, the nuances with stops, take profits and position tracking remain at the discretion of the trader.

This also includes automated systems that work according to the logic of statistical arbitrage. The profit on one transaction is small, but this can be compensated by the working volume.Advantages and disadvantages of correlation

Among the advantages of using this factor are:

  • The ability to pre-determine upcoming movements in a currency pair. This allows you to enter the market at a better price.
  • The ability to manage risks in both active trading and investing.
  • Statistical arbitrage is a risk-free trading tactic that allows you to earn regardless of the direction of price movement. This style of trading solves the question of how to make money on the correlation of currency pairs in a fully automatic mode.

There are no ideal tools in trading; correlation has a number of disadvantages:

  • This is a dynamic setting. For a number of assets, there are long-term relationships due to fundamental factors, but in the case of currency pairs, such relationships can collapse over time. It is impossible to predict when this will happen.
  • Correlation can be misleading. Even if the relationship between assets fluctuates around 80-90%, this does not mean that the movements of the charts will copy each other.

These shortcomings do not make the correlation useless and do not reduce its importance in the work of a trader/investor.

Conclusion

The correlation of currency pairs in Forex is more often used as an auxiliary tool in trading. The phenomenon of connection between 2 assets allows you to balance risks, find profitable entry points and generally increase the efficiency of trading. Correlation is also useful in investing, risk hedging is important, and it is thanks to the study of the relationship between various assets that the investor gets the opportunity to hedge on the eve of crises.

At the same time, correlation is not a magic tool, but only a coefficient characterizing the level of connection between financial instruments. It is important to understand the nature of this connection and not rely on it 100%.

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