How to use currency correlation in Forex & CFD market
All markets are somehow connected with each other. That means if one market goes up there is a high probability that there is also a market that will reflect this situation and will go up as well. But to understand how the markets correlate, you need to know the connection between these markets. Towards this very purpose, we use currency correlation tables in which we can find out how certainly one market will influence the other.
What is correlation?
Currency correlation is the measurement of the relationship between two currency pairs resulting in a correlation coefficient. So basically how certain it is that one market will have an impact on the other market. The correlation is measured in the range of -100 to +100 (or sometimes -1 to +1), a negative value will result in a negative market correlation (So if one market goes up, the other one will go down).
Oppositely if the value is positive, both markets will go simultaneously up. This shown on an example, it can look as follows: the currency pair EUR/USD goes up and with it also the currency pairs: EUR/HKD (+0.98), EUR/SGD (+0.92) and many others. On the other hand currency pair, USD/DKK has -1 negative correction. Simply put, that's because the dollar and the euro are such strong currencies that they are capable of dictating the direction of other currencies with which they pair. The weaker the other currency in the pair is, the easier it is for them.
How Forex pairs and CFD instruments correlate
The correlation coefficient represents the similarity of the movements between two underlying assets over a specified time period.
- 0.0 to 0.2 Negligible correlation, very weak
- 0.2 to 0.4 Insignificant correlation, low
- 0 Arbitrary correlation, random
- 0.4 to 0.7 Moderate correlation, average
- 0.7 to 0.9 Robust correlation, strong
- 0.9 to 1.0 Very strong correlation
Online currency correlation table
Tips and tricks for Forex & CFD Market currency correlation trading
Eliminate contradictory trading. If you open a long position for EUR/AUD you shouldn't also open a long position for AUD/CHF in the same time. These pairs correlate with each other, negatively. So if one of these positions would be making a profit, it might most certainly mean that the other one is losing. Therefore the only one who would be making a profit out of this situation is the broker (thanks to the spread from 2 opened positions).
Diversify your portfolio and reduce the risk. With understanding the currency correlation you are able not to make direct trades. So when the US Federal Reserve raises interest rates you do not have to always straightforwardly trade EUR/USD, but you can rather grasp the EUR/HKD (which has a correlation around 1). Such a strong correlation means that these pairs will almost in 100% cases move simultaneously along.
Take advantage of the leverage with diversification. Check pairs with strong or perfect correlation and create rather two positions than just a one. By doing so you can benefit from double leverage. But be careful can you not only leverage your winnings but of course also your losses.
Examples of correlation in practice:
Bellow, you can see a positive correlation of forex pairs EUR/USD and EUR/HDK. Notice that whenever the price of EUR/USD goes up, so does the price of EUR/HDK. The charts almost look like if they were for the same forex pair, but know that they are not, they are just so damn similar.
Not to omit negative correlation, look at these two 1-hour charts, the first one for the EUR/USD and the second one for the USD/CHF. Notice that their movement is completely opposite. When one currency pair goes up, the other one goes down.