eToro – Forex Trading Forum

by **Tropezienne** on 22 Sep 2008

What is Currency Correlation ?

I have decided , after months of reading about forex, that it might be good for me to select up to 3 or 4 pairs to trade with and to get to know their characteristics, rather than messing around with 15 pairs. I chose GBP EUR and USD and was considering CHF as a fourth and I experimented with these four on my demo account.

I noticed that when I traded EUR/USD I would get similar results to GBP/USD - but that if I traded EUR/USD at the same time as CHF/USD then results moved in opposite directions.

I fished around the virtual world to find out more about currency pairs and their trading characteristics. What I discovered is that the tendency for certain currency pairs to move in the same or opposite direction had been discovered long before I came along ! (No surprise there).

These tendencies can be statistically measured and the pairs are given a score - called a ‘correlation coefficient’. The range is from a ‘plus 1’ to a ‘minus 1’

A ‘+1’ means that the currency pair will move in the same direction 100% of the time; a ‘-1’ indicates a pair that will always in the opposite direction; a zero tells us that there is no relation between the pair.

More to follow on this .....

Julie

http://who-gives-a-forex.blogspot.com/

by **Tropezienne** on 22 Sep 2008

This was a really exciting discovery for me - I had already realised that if I was doing well with EUR/USD that I should seriously consider opening a similar position with GBP/USD. Now I know why - they have a strong correlation coefficient of +0.90.

On the other hand USD/CHF and EUR/USD score low : -0.90. Which means that they trade in the opposite direction almost 100% of the time.

Knowing this must be a very powerful trading consideration.

These currency pairs move in the same direction :

These move in opposite directions:

How can we use such information ? Obviously, I would not choose to trade at the same time 2 pairs that cancel each other out (EUR/USD and USD/CHF). But I might open two postions with pairs that move in the same direction.

I’m not sure how to ‘diversify’ my trades.

Any advice?

Julie

http://who-gives-a-forex.blogspot.com/

by **Tropezienne** on 02 Oct 2008

I was wondering if this information could help a trader to hedge one currency against another ? For example, if I were to BUY both USD/CHF and EUR/USD at the same time - these being pairs that move in the opposite direction - I assume that if one is making losses the other will be in profit ? Does it work like that - it might be that, because of the losses, I would not gain as much - but then I would not lose as much either.

Or is that premise too simplistic?

Also, is hedging a safe game to play? It seems far too clever for me.

Or maybe, if I had a position open on a currency pair that was doing well I could open positions on pairs that move in the same direction as the profitable pair with the reasonable expectation that they to would do as well ?

Does anybody out there make good (profitable) use of such information ?

Julie

http://who-gives-a-forex.blogspot.com/

by **Tropezienne** on 16 Oct 2008

More about Currency Correlation

Basically, the correlation number gives you an idea whether or not pairs move in the same direction or the opposite direction. Knowing how closely correlated currency pairs are is a great way of measuring exposure and risk.

Such info is especially useful if you have an open position and want to open another position. Eg: you have a AUD/USD short position and you think that there might be a possible long setup with the EUR/USD. This is the point at which knowing the correlation of these 2 pairs will help you to make an informed decision.

Look at a 5-day correlation table you want to see a figure of at least .50 and preferably .80. The table shows a correlation value of .24. So the correlation is low - which means that the 2 pairs don’t move in the same way. So to go short on AUD/USD and long on EUR/USD should not affect each others position.

But what if correlation was high? Eg: the correlation between EUR/USD and USD/CHF on a 5-day table is -.96. This is a strong negative correlation indicating that they are highly likely to move in opposite directions. To go long on one and short on the other would be like opening the same position twice, thus increasing your risk.

by **Tropezienne** on 21 Oct 2008

I’ve been trying to understand about diversification when trading. I wanted to explore this because I read that currency correlation can be used when a trader wants to diversify his risks.

EG: if we look at a pair that have a currency correlation of +0.70 (say EURUSD and AUDUSD) - these two pairs move mostly in the same direction. The main point is that their correlation is not perfect - this is the condition that we need to diversify.

So - if we decide from our trading preparation that the dollar is getting weaker, a good diversification would be to place half of a BUY order on EURUSD and half on AUDUSD

By splitting - or diversifying - the order the trader is protected from sudden changes (the price might shoot up for example). Because these currencies are not 100% correlated the trader has time to react.

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