How To Use Currency Correlation In Your Trading

As a Forex trader, there are certain market dynamics that you need to be aware of. These dynamics can dictate your success. One of those dynamics is currency correlation. In this article, I explain how to use currency correlation in your trading.

What is currency correlation?

During a trading session, you may have noticed that certain currency pairs tend to move in the same direction. You might have also spotted currency pairs that move in the opposite direction. This doesn’t happen by accident – it’s currency correlation.

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Generally, we use the word “correlation” to show a statistical link between entities. It’s no different in the world of Forex.

Some currency pairs have a positive correlation – which means they tend to move in the same price direction. Meanwhile, other currency pairs have a negative correlation. It means when one currency pair moves up in price, the other currency pair tends to fall. Finally, some currencies have no link at all. This means their respective price movements are random in relation to one another.

Why are there links between currencies?

This is actually quite simple. The reason relationships exist between currency pairs is because they are traded in pairs. Remember, we don’t trade currencies in isolation.

This is what causes correlations between currencies. It’s important to note that correlations also move over time. In other words, they constantly change. This is something I explore in further detail in the sections below.

The impact on your trading

So currency correlation is a pretty simple concept to understand. Some currency pairs are linked – meaning the price of those pairs tends to move in the same or opposite direction.

You might be asking why this matters. But if you’re planning to trade multiple currency pairs at the same time – it really does.

For example, if you’re planning to trade two currency pairs that happen to be negatively correlated,you run the risk of exposing your capital. On the other hand, if you trade positively correlated currency pairs,you could boost your profitability. This is a concept I explain in further detail in the video below.

Explaining correlation coefficient

It’s very easy to find the relationship between two currency pairs. We just need to look for something called the correlation coefficient.

Now, what you need to know is that the correlation between two currency pairs is rarely absolute. For example, two positively correlated pairs may move in opposite directions from time to time.

This phenomenon is represented numerically by something called a coefficient. Coefficients are usually listed in a table between the numbers -1 and +1.

-1 represents 100% negative correlation
+1 represents a 100% positive correlation
0 represents no correlation
Numbers in between reflect different percentages. For instance, +0.90 represents a 90% positive correlation. This means that the two pairs will move in the same direction 90% of the time (please note that some tables display coefficients as a percentage, not a number).

Hopefully, you’ll now recognise that you want to avoid trading pairs that have a coefficient close to -1 at the same time. In fact, if you have multiple positions open in the same session, you need to ensure that they have a coefficient as close to +1 as possible.

You can also view correlation coefficients over different timeframes (much like a trading chart). When you check coefficients, ensure you reference the relevant timeframe for your trade. If you don’t do this, there is a chance your currency correlation check won’t be accurate.

Currency correlations

There are many free currency correlation tables you can use online. One of my favourites is from Myfxbook. It’s a comprehensive table that can help with forward planning.

Plus, if you trade with a platform such as MetaTrader 4, you should have access to widgets which update currency correlation coefficients in real-time. This can be very useful in live trading scenarios.