Understanding price relationships between various currency pairs allows you to get a deeper insight on how to develop high probability Setups.
Awareness of currency correlation can help to reduce risk, improve hedging and diversify trading instruments.
In this lesson we will introduce you to using intermarket correlations.
Correlation is a statistical measure of the relationship between two trading assets.
The correlation between pairs shows a certain similarity in the movement in the market. For example, they can move in the same direction, or move in the opposite direction within a particular period.
Above you can see a good example of 2 charts that are very closely connected.
If you look closely at both the charts of EURUSD and the DXY you can see that they make the same movements but then opposite to each other.
It is therefore also very useful to check how the DXY moves, for example with EURUSD, to have an even higher chance of success on your setup!
We can divide different pairs that have a correlation with each other into different catogories. (+1 / -1 / 0 )
We have a +1 catogory which means that the pairs move 100% in the same direction.
EURUSD and the GBPUSD, for example.
If the EURUSD is bullish and goes up, the GBPUSD will also go up.
Then we have the -1 catogory.
This means that 2 pairs move exactly the opposite of each other.
As you can see in the example above of the EUR / USD and the DXY.
So if the EURUSD goes up, the DXY will go down.
And finally we have the 0 catogory, which is actually very simple and simply means that the pairs move randomly and have no link (correlation) with each other.
|Examples of strong positive correlations (Yearly time frame):|
EUR/USD and GBP/USD (+ 0.89)
EUR/USD and AUD/USD (+ 0.81)
EUR/USD and EUR/CHF (+ 0.93)
AUD/USD and Gold (+ 0.75)
|Examples of strong negative correlations (Yearly time frame):|
EUR/USD and USD/CHF (- 0.85)
USD/CAD and AUD/USD (- 0.88)
AUD/NZD and NZD/SGD (- 0.78)
USD/JPY and Gold (- 0.78)
-CAD and the CRUDE OIL have a positive correlation, due to the fact that Canada is a major oil producer and exporter.
-AUD and Gold have a positive correlation, because Australia is a significant gold producer and exporter.
-JPY and Gold are viewed as safe havens in times of uncertainty and these two are also positively correlated.
-USD and Gold typically have a negative correlation.
When the U.S. dollar starts to lose its value amid rising inflation, investors seek alternative stores of value such as gold.
-EUR and DXY have a negative correlation and both move in the opposite direction.
Be aware that currency correlations are constantly changing over time due to various economic and political factors. These often include diverging monetary policies, commodity prices, changes in Central Bank policy etc. Strong correlation is not guaranteed to be the same in the future what makes following the shift in correlations even more important. I recommend to check long-term correlation to get a better perspective.