Imagine you’re at a party, and you notice that whenever two friends start chatting, another pair of friends always seem to drift apart.
This is a bit like how currencies behave in the forex market. When one currency strengthens, another might weaken, and understanding these relationships can make a big difference in how you trade.
When it comes to trading the foreign exchange market, it’s important to be aware of the relationships between different currency pairs.
Have you ever noticed that when a certain currency pair rises, another currency pair falls?
Or how about when that same currency pair falls, another currency pair seems to copy it and falls also?
If the answer is “yes,” you’ve just witnessed currency correlation in action!
If you answered “no,” you need to stop doing less important things like sleeping, eating, playing Fortnite, and instead spend more time watching charts.
But no worries because we’re going to start with the basics and break it down yo…Currency. Correlation.
The first half… easy. Currency. No explanation is needed.
The second half. Still easy. Correlation: a relationship between two things.
In this lesson, you’ll learn what currency correlation is and how you can use it to help you become a smarter trader and make more responsible risk management decisions.
What is Currency Correlation?
In the financial world, correlation is a statistical measure of how two securities move in relation to each other.
Currency correlation, then, tells us whether two currency pairs move in the same, opposite, or totally random direction, over some period of time.
When trading currencies, it’s important to remember that since currencies are traded in pairs, no single currency pair is ever totally isolated. (Did we just confuse you with our “currencies” tongue-twister sentence there?)
Unless you plan on trading just one pair at a time, it’s crucial that you understand how different currency pairs move in relation to each other.
ESPECIALLY if you’re not familiar with how currency correlations can affect the amount of risk you’re exposing your trading account to.If you don’t know what the heck you’re doing when trading multiple pairs simultaneously in your trading account, you can get KILLED!
Murdefied! Destroyed! We can’t stress this enough.
Do NOT be ignorant about correlations.
Correlation Coefficient
Correlation is computed into what is known as the correlation coefficient, which ranges between -1 and +1.
The correlation coefficient measures how strongly two variables are related to each other. It’s like a relationship status for data points: “It’s complicated”, “Just friends”, or “Soulmates”.
A perfect positive correlation (a correlation coefficient of +1) implies that the two currency pairs will move in the same direction 100% of the time.
A perfect negative correlation (a correlation coefficient of -1) means that the two currency pairs will move in the opposite direction 100% of the time.
If the correlation is 0, the movements between two currency pairs are said to have uh ZERO or NO correlation, they are completely independent and random from each other. We have no idea how one pair will move in relation to the other.
It’s important to remember that correlation does not imply causation.
Just because two things move together doesn’t mean one causes the other. It’s like saying just because roosters crow before sunrise doesn’t mean the crowing causes the sun to rise.
In a nutshell, currency correlation refers to the tendency of certain currency pairs to move in sync with each other, either in the same direction (positive correlation) or in opposite directions (negative correlation).
For your convenience, we’ve created a Currency Correlation Calculator. Check it out!