However, we can note that over an even longer period of time – a year – we can see stronger correlations:
Examples of Strong Positive Correlations (Over a Yearly Time Frame)
EUR/USD & GBP/USD (+ 0.81)
EUR/USD & AUD/USD (+ 0.79)
Examples of Strong Negative Correlations (Over A Yearly Time Frame)
EUR/USD & USD/CHF (- 0.54)
USD/CAD & AUD/USD (- 0.67)
Why Currency Pairs Have An Inverse Correlation
As you already know about the majors and minors of forex pairs, you will notice that the USD is paired with the majority of the currency pairs.
As you know by now, currency pairs move in a correlated way, however, it is possible for them to have a perfect negative correlation.
When a currency pair move is a perfect negative correlation, this is represented with a 0.
This means whenever a currency pair moves upwards, the perfect negative correlation currency pair moves downwards – pip for pip.
You see, when the EUR/USD is going downwards it is because the USD strength is gaining. What this means is traders are buying the USD as they believe in the prospects of the US economic future vs. the Euro.
So in practice, they are selling the EUR to buy the USD – thus triggering the downward move.
However, with an inverse correlation:
If the USD is strengthening – then commonly, pairs with USD at the front – like USD/CAD, would rise.
In this case, forex traders are buying the USD and selling the CAD.
Again, the USD is favoured and the markets are buying USD – thus the chart of the USD/CAD will be going upwards.
Now, why the USD? Because it is the currency reserve.
So anything affecting the USD will have a larger effect on all USD forex pair crosses.
Change of Currency Correlation in Forex
You should be aware and alert of the fact that currency correlations are changing continuously over time.
The reason behind these changes is the numerous political as well as economic factors. The factors usually include separate monetary policies, prices of the commodity, Policy changes in central banks, and more.
It is imperative to stay updated on currency relationships that are constantly shifting. It is advisable to check for correlations that are long-term and obtain a deeper perspective.
Currency correlations can be a strong tool one could utilize for developing a forex pair correlation strategy of high-probability.
You will be guided in risk management, especially if you keep track of the correlation coefficients on a daily basis, weekly basis, monthly, or yearly time frames.
Trading on Forex Pair Correlations
You should identify which pairs of currency have a positive type or negative type of correlation with each other, in order to make a trade.
In other sense, a user will unlock two within the same type of positions if there is a positive correlation, or two positions that are opposing if there is a negative correlation.
If there is a negative correlation between AUD/USD and USD/CAD, possessing a lengthy position on both the pairs will cancel each other out effectively. It happens as the pairs are predicted to proceed in opposing directions.
However, if there is a perfectly positive correlation, then separate lengthy positions within separate pairs may help to boost your profits. But it can also maximize your losses if you have a wrong forecast.
Traders tend to commonly get hold of positions on pairs that are correlated to expand themselves while preserving the same general direction, i.e., either upwards or downwards.
It is done for protecting themselves from the probable risk of a single pair proceeding against them. But the traders will still have the chance to benefit from the other available pair if it ever happens.
It is known that currency pairs that are highly correlated tend to be rare. Uncertainty always dwells in the financial markets.
You could also make a trade on correlations of forex pair to hedge your risk within your currency trades that are active.
For instance, you can take out a lengthy and high position or place on USD/CHF to hedge any type of losses that you meet on an active high position of EUR/USD. It is because these pairs of currency own a powerful historical correlation that is negative.
Summing Up Forex Pairs That Correlate
The Correlations of currency could be either of the positive or negative types.
Correlations, whether the positive or negative type, offers a chance to acknowledge a bigger profit or in hedging the exposure you get.
The currency also could be correlated with the utility or value of the exports in a commodity like gold and oil. By entering the currency pair, time frame, and a number of periods, the forex pair correlation calculator can be used to calculate correlations currency pairs that are major and exotic over multiple time frames.
One of the key takeaways from this is that if you know how currency pairs correlate you can use it as confirmation bias of the market sentiment before entering a trade.
Not only this, but you can also use it to confirm the trend if the USD is strengthening, then all positively correlated forex pairs should be moving downwards and the negatively correlated pairs moving upwards.
You can maximise your opportunities with forex pairs that correlate by combining them with candlestick patterns to find trading opportunities.