If you have experience in trading Forex, you’ve probably seen Forex pair correlation in action. You might have noticed that when a certain currency pair rises, another falls. Or that when one pair rises, another currency pair rises right along with it. Effective Forex traders understand how certain financial markets are connected — or correlated.
What is Forex Pair Correlation?
In currency trading, Forex pair correlation measures how two markets move in relation to each other, and there are two types of correlation:
- A positive correlation means two currency pairs move in a similar direction, like dance partners.
- A negative correlation means that two currency pairs move in opposite directions.
Correlation is expressed with a coefficient — which has a value of -1 to 1 (or sometimes -100 to 100). A negative number implies a negative correlation, while a positive number implies a positive correlation. The bigger the number, either positive or negative, indicates a stronger correlation.
Highly Correlated Currency Pairs: Reading the Correlation Tables
Currency pairs with close economic ties tend to be the most highly correlated. EUR/USD and GBP/USD are frequently positively correlated because of the relationship between the Euro and the British pound. Both currencies share geographic proximity and prominence as two of the world’s most widely held reserve currencies.
To read a forex pair correlation table, simply find the intersection of two pairs and determine their correlation over the given period. Remember, the closer to +1 or -1, the higher the correlation. A handy correlation table is available on myFXbook here.
The table below gives examples of the correlations between some of the most traded currencies in the world for the daily chart:
How Forex Pair Correlation Can Help You Trade
Forex pair correlations can provide an opportunity for profit. They can also be used to hedge your positions and limit risk. If you know that one currency pair exhibits a correlation with another, you can open another position to maximize profit, or open a position to hedge your exposure against increased market volatility.
Traders will normally take positions on correlated pairs so that they can diversify their net position while preserving the same general direction – either up or down. Thus, if a single pair moved against them, they have a safeguard in place, since they can still profit from the other pair in that event. Perfectly correlated pairs are very rare though and there’s always a degree of uncertainty and risk in financial markets.
Though, if you’ve forecasted incorrectly when trading forex pair correlations, or if the markets move in a way you hadn’t anticipated, you could incur steeper losses, or your hedge might be less effective.
It should be noted that the strength of the Forex pair correlation depends, in part, on the time of day and trading volumes for both pairs. For example, Euro (EUR) pairs will be more active during the London (or European) session between 8 AM and 4 PM UK time.
Sample EUR/USD and GBP/USD Correlation Trade
As mentioned above, EUR/USD and GBP/USD are positively correlated forex pairs — meaning if one moves up, the other will likely do the same and vice versa. The three currencies all have strong economic ties to one another between their economies.
Consider the following example.
A trader might open two positions, one on each of the pairs if the correlation in the market were strong at the time. They might take a short position on both if they thought the one was about to fall and take long positions if they thought one was about to increase. Either way, the trader would be looking to increase their profit, while diversifying their positions.
Notable Examples of Forex Correlation Pairs
While correlations can be found among a wide variety of instruments, below are some of the most common and notable correlations in the Forex market:
- EUR/USD and GBP/USD | As mentioned, these two pairs have a strong positive correlation due to ties between the economies of each.
- EUR/USD and USD/CHF | The correlation between EUR/USD and USD/CHF is negative, often moving in opposite directions.
- CAD and crude oil | Forex pair correlation is not just for currency pairs. In this instance, several factors weigh in the correlation. The Canadian economy is strongly tied to oil production, while oil is largely traded in U.S. dollars. Thus, there is a strong positive correlation.
- AUD and gold | Since Australia is a net exporter of gold, its currency exhibits a strong positive correlation with the price of gold, especially in the AUD/USD currency pair. When the price of gold appreciates so does the price of AUD/USD; when gold prices fall, AUD/USD also falls.
One last point to think about is that correlations can, and do, shift. Market sentiment and worldwide economic forces shift often. Thus, traders are urged to scrutinize correlations closely; it could mean the difference between a winning and losing portfolio.
Disclaimer: All information provided here is intended solely for study purposes related to trading financial markets and does not serve in any way as a specific investment recommendation, business recommendation, investment opportunity, analysis, or similar general recommendation regarding the trading of investment instruments. The content, in its entirety or parts, is the sole opinion of SurgeTrader and is intended for educational purposes only. The historical results and/or track record does not imply that the same progress is replicable and does not guarantee profits or future profitable trading records or any promises whatsoever. Trading in financial markets is a high-risk activity and it is advised not to risk more than one can afford to lose.