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Currency Correlation | Forex Correlations - ForexAbode School
Last Updated (Friday, 23 December 2011 03:06) GMT
Currency Correlation/Forex Correlation
It could be interesting to see how the currency correlation values change over the time. For changing correlations, please check at the bottom of this page for the links for the comparison during past one year and past one week (updated on weekends).
Overview:
Currencies are priced in pairs, no single Forex pair trades completely independently of the others. How one currency pair moves relative to the any other currency pair is the correlation between those two pairs. While trading Forex, especially with multiple currency pairs, understanding and keeping a track of currency (Forex) correlation is very important especially if we trade with multiple currency pairs simultaneously.
Let's say, currency pair "A" moves in the same direction as pair "B" and we have been following up pair A's move very closely. We expect it to go up and we buy. We have not been following up pair "B" so closely and suddenly we look into that and the fundamentals or technical analysis suggests us that this pair may go down. We short sell. What eventually would happen that we would end up having profit on one pair and loss on the other as they moved in same direction. Similar case would happen if we simultaneously go long or short on two pairs which move in opposite directions.
Once we know about these correlations and their changes with time, we can take advantage of them to control our Forex portfolio's exposure.
Forex Correlation Value Range:
The currency correlation coefficient ranges between -1 and +1.
A correlation of +1 implies that the two Forex pairs will move in the same direction 100% of the time. A coefficient of -1 implies the two currency pairs will move in the opposite direction 100% of the time. A coefficient of zero implies that the relationship between the currency pairs is completely random.
Positive Correlations:
A positive figure but less than +1 means that the currency pairs generally move in same direction but not always. A value closer to +1 means that most of the time they move in the same direction.
Negative Correlations:
A negative figure but more than -1 means that the currency pairs generally move in opposite direction but not always. A value closer to -1 means that most of the time they move in opposite directions.
How to Interpret the Currency Correlation Tables:
Some currency pairs may be correlated strongly and some may not be so strongly correlated. The pairs we need to watch are the once which are strongly correlated, either positively or negatively. Currency pairs which have strong positive correlation, will tend to move in the same direction, most of the time . The pairs which are strongly but negatively correlated will tend to move in the opposite direction, most of the time. Please note that volatility may be very different even if the pairs are strongly correlated.
Interpretation of the correlation coefficient values:
| Correlation Coefficient |
Interpretation of Correlation |
| 0.0 to 0.2 |
Very weak to negligible |
| 0.2 to 0.4 |
Weak / low (not very significant) |
| 0.4 to 0.7 |
Moderate |
| 0.7 to 0.9 |
Strong |
| 0.9 to 1.0 |
Very strong |
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How to use currency correlation?
Well, your slow speed because of an occasional traffic jam on the expressway does not really indicate that the average speed you would end up on the road will be same. The correlation is dynamic and changes with the time. Take a note of the correlation of the past few days and compare it with the value in the long term average, say past one year. If the short term value is far different from the long term value, maybe it's offering you a chance to place a trade, but how? Let's say that currency pairs A and B and C have a correlation value in the range of 0.90 to 0.98 during past one year. It means that these all move in almost the same direction, most of the time. When currency pair A moves up, currency pair B and C also move up. Suddenly you notice that during the past one month or one week the correlation value of the currency pairs A and B is 0.10 i.e. moving in the same direction but not always but the coefficient value of A and C is almost in the same range. To clarify as an example let's say three cars are moving towards the same destination. Now for some time 2 remains moving in the same direction but the third falls behind. But we can assume that ultimately the third may have to catch up. So what do we do? Well, we find out which one is slow and ride that. When we convert this car example to currency trading, suppose three currency pairs move in the same direction and have been moving up with a correlation over 0.60 in the long-term and we find that suddenly the correlation value for one pair against the other two has become 0.20, that may be an opportunity to buy this currency pair with the expectation that ultimately it may catch up with the other two.
Well, you may find various strategies but the best use is in managing the multi-currency pair portfolio so that we do not enter the trades which conflict each other. |
Currency Correlation Calculator
You may calculate the correlation value yourself by using this online currency correlation calculator.
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