Forex Correlation Cheat Sheet – All You Have To Know
Dealing with different currency pairs can complicate forex trading. Understanding forex correlations can greatly enhance your trading strategy by helping you manage risks and take advantage of market movements. So here is a useful forex correlation cheat sheet for all beginner traders.
This guide provides a simple overview of forex correlations, including examples and practical tips on using them effectively. Forex trading can be complex when dealing with various currency pairs.
Understanding forex correlations can improve your trading strategy by managing risks and capitalising on market movements.
This guide explains forex correlations, with examples and tips on how to use them effectively.
Understanding Currency Pairs Correlations
Forex currency correlation pairs are currency trades showing a predictable price movement relationship.
They can be positively or negatively correlated. This concept works by analysing the relationship between different currency pairs. Here’s a breakdown of how this concept works
In the forex market, a currency pair involves trading one currency against another. The first currency listed (the base currency) is bought, while the second (the quote currency) is sold. For example, in the GBP/USD pair, you buy British Pounds and sell US Dollars.
Forex correlations or currency pair correlations allow traders to identify whether one currency pair/ forex pair will move similarly to another.
Two currency pairs represent a positive correlation when they go up or down simultaneously.
However, if one currency pair moves in the opposite direction of the other, meaning one goes up while the other goes down, this indicates a negative correlation.
Currency correlations are important to monitor and understand when analysing prices and other commodities, stocks or instruments.
What Does Correlated Forex Mairs Mean?
Currency pairs are correlated when they move dependent on each other. This can happen when the currencies in each pair are the same or include the same economies.
For example, EUR/USD and GBP/USD contain USD as a common factor. On top of this the Eurozone and Great Britain are closely tied economies trading together. These factors are a core reason for a correlated forex pair.
Types of Forex Correlations
- Positively Correlated Forex Pairs: When two currency pairs move in the same direction, they are positively correlated. For example, EUR/USD and GBP/USD are highly correlated because similar economic factors often influence them.
- Negatively Correlated Forex Pairs: These pairs move in opposite directions. A classic example is USD/JPY and EUR/USD. When the dollar strengthens against the yen, it often weakens against the euro.
The strength of these correlations is measured using a correlation coefficient, which ranges from -1 to 1. A coefficient close to 1 indicates a strong positive correlation, while a coefficient close to -1 indicates a strong negative correlation.
Positive Correlation
When two currency pairs move in the same direction, they are positively correlated. This typically occurs when the pairs share a common currency. For instance, GBP/USD and EUR/USD both involve the US Dollar as quote currency.
Due to the interconnected economies of Europe and the UK, economic events that affect the USD often cause GBP/USD and EUR/USD to move in a similar direction. Traders can use this information to predict movements in one pair based on changes in the other.
Negative Correlation
Conversely, currency pairs that typically move in opposite directions are negatively correlated. A prime example is EUR/USD and USD/CHF. In this case, the US Dollar is the base currency in USD/CHF and the quote currency in EUR/USD.
If the USD strengthens, it will likely cause EUR/USD to drop (since the USD is the counter currency) and USD/CHF to rise (since the USD is the base currency).
Traders often use negatively correlated pairs for hedging strategies, opening opposing positions on the two pairs to offset potential losses.
The Correlation Coefficient
The correlation coefficient, ranging from -1 to 1, measures the degree to which pairs correlate. A coefficient of 1 indicates that the pairs move in the same direction 100% of the time, while -1 indicates they move in opposite directions. A coefficient close to 0 means the movements between the pairs have no reliable correlation.
Forex Correlation Tables
Many traders utilise forex correlation tables or matrices to quickly view and assess the relationships between various currency pairs.
These tables display correlation coefficients and help traders make informed decisions based on the expected movements of correlated or anti-correlated pairs. These tools are particularly useful in developing strategies for multiple currency exposures and managing risk by spotting potential for hedging.
Correlated Forex Pairs List
Forex Pairs that Move in the SAME Direction
- EUR/USD and GBP/USD
- EUR/USD and NZD/USD
- EUR/USD and AUD/USD
- USD/CHF and USD/JPY
- AUD/USD and NZD/USD
Forex Pairs That Move in the OPPOSITE Direction
- EUR/USD and USD/CHF
- USD/CAD and AUD/USD
- GBP/USD and USD/JPY
- USD/JPY and AUD/USD
- GBP/USD and USD/CHF
Practical Application in Trading
Traders can use knowledge of forex correlations to their advantage by:
- Predicting Movements: If you observe a movement in one currency pair, you can anticipate a similar movement in a positively correlated pair.
- Hedging: Traders can reduce risk by taking opposing positions in negatively correlated pairs. For example, if you go long on EUR/USD, you might go short on USD/CHF to hedge your bets.
- Capitalising on Lags: Sometimes, one correlated pair may move before another. Observant traders can capitalise on this lag by trading the pair that has yet to move.
Example of Trading Strategy
Let’s consider a scenario where you notice that EUR/USD has made a significant move upward. If GBP/USD hasn’t yet moved but historically follows EUR/USD, you might anticipate a similar upward movement soon. Based on this, you could place a long position on GBP/USD, expecting it to catch up.
Understanding forex correlations provides a strategic edge in predicting how pairs will move relative to each other, which can be crucial for hedging and leveraging potential trading opportunities.
How to Trade Forex Correlation?
Trading forex correlation involves several strategic steps:
- Identify Correlated Pairs: Use a forex correlation cheat sheet to identify closely tied pairs. This sheet lists various pairs and their corresponding correlation coefficients over different time frames.
- Set Up Trades: Decide whether to trade on the expectation that the correlation will continue or revert. For example, if EUR/USD and GBP/USD are positively correlated and EUR/USD makes a significant move, you might expect GBP/USD to follow.
- Manage Risk: Implement risk management strategies, such as setting stop losses, to protect against the possibility that the correlation fails or reverses unexpectedly.
- Monitor External Influences: Economic announcements, changes in monetary policy, and significant global events can affect correlations. Monitoring these can help you anticipate changes in correlated pairs.
Examples of FX Correlations
- EUR/USD and GBP/USD
The Euro and the British Pound exhibit a positive correlation because they often react similarly to movements in the U.S. dollar and changes in the global economic outlook.
- AUD/USD and USD/CAD
This pair often exhibits a negative correlation due to their relationship with commodity prices, especially crude oil. The Canadian dollar gains when oil prices rise as a commodity currency, while the Australian dollar might not see similar benefits.
- USD/JPY and Stock Market
Often, USD/JPY is positively correlated with stock markets, particularly in the U.S. A rise in stock markets can lead to a rise in USD/JPY, reflecting a risk-on sentiment where investors buy U.S. dollars to invest in stocks.
Bottom Line
Understanding forex correlations is crucial for anyone trading in the forex market. By using a forex correlation cheat sheet, traders can enhance their understanding of how pairs move about one another, allowing for more informed trading decisions.
This knowledge helps identify trading opportunities and aids in risk management, making it a fundamental aspect of successful forex trading. Whether trading EUR/USD and GBP/USD or exploring the connections between commodities and currencies, a solid grasp of forex correlations can significantly impact your trading outcomes.
