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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.
On the other hand, traders may be more risk averse and opt to use currency correlations to reduce risk. Potentially reduce risk by splitting across more economies. Alternatively, a trader may use correlation to assess a value of a currency pair. Therefore, not directly trading the correlation but using the correlation within their analysis. 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.
What we can see in the correlation table is that there are positive and negative correlations. 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. This generally creates an negative correlation as it's essentially flipped upside down! Commodities also have correlations between currency pairs and are used widely when forex trading. This relationship shows the risk appetite of investors. 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.
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.
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. The formula column will automatically calculate how much the price has increased or decreased.
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:. This rarely happens. A correlation efficient of 0 shows that the two currency pairs have no correlation, and they are independent of each other. These are what we call non correlated forex pairs, and no trader, no matter how experienced or knowledgeable, they are can predict how one will move on account of the other.
Unless you have the skills needed to calculate correlation on excel, you might be better off seeking this information from your forex software. Most of them have tables showing a correlation between common currency pairs, and this is an easy way to use them for your trading strategy. You will find a positive correlation displayed as a figure with no sign and negative with the minus sign. Some have color-coding with negatives in red and positives in a green.
Note that the correlation scale is a sliding one, and as the number or shade of color moves from positive to negative, the less or opposite a currency pair is related. It is vital to understand these figures as they have a significant impact on trading decisions.
Are you already wondering how all this technical stuff will help you make profits? We will break it down here. Typically, you would want to trade in different currency pairs so that when one takes a sudden nosedive, you can still recover money from another.
Correlation gives you an information platform that you can use to decide which currency pairs will help you diversify risk. In the absence of correlation, you can trade two currency pairs with the impression that you are diversifying your investment when they are positively correlated. This way, if one takes a nosedive, your entire investment will go down the drain. When trading non correlated forex pairs, that is, ones with zero correlation, you will need to do it independently or using other sources of information.
This is because these pairs move independently, and you cannot anticipate the turn they will take. Lastly, the correlation will help you avoid situations that cancel each other. If you invest in pairs that are negatively correlated, they will cancel each other and get you back to where you are.
Correlation is an essential concept in forex trading and can help you to hedge or diversify your exposure in the market. It gives you a basis for reference when trading currency pairs and will guide you to make informed decisions rather than relying on guesswork. The information regarding the correlation between different currencies is available online, and if you have a bias towards one, then you could use it as a basis to trade in the other. Non correlated forex pairs are riskier but can still be part of your strategy if you want to avoid instances where you take a double hit.
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