Using Currency Correlation
Currency is always priced in a pair and understanding the currency correlation is very important. For instance, pair of currency with name ‘A’ goes in the similar direction as currency pair ‘B’ and when it goes up, you buy it immediately. Though you do not follow the pair of currency ‘B’, but due to some technical analysis, you make your mind to sell it shortly. So, what would be the ultimate result? When pairs of currency move in the similar direction, one pair may eventually end up with a profit and second pair may suffer loss. Once you understand these correlations, it becomes very easy to take their advantage.
The correlation coefficient lies between +1 and -1. The correlation +1 means that the pairs will go in the similar direction and -1 implies that the pairs will go in the contradictory directions. Zero correlation indicates random currency pairs.
Positive Correlation
The positive figures less than +1 show that pairs may go in same way, but it is not necessary. However, the positive figures with value near to +1 state that mostly the pair will go in the similar direction.
Negative Correlation
The negative figures less than -1 show that pairs may go in different ways, but it is not obligatory. However, the negative figures with value near to -1 imply that mostly the pair will go in the contradictory direction.
Using Currency Correlation in Forex Trading
When on an expressway, if your speed is slow due to traffic jam, it does not means that the speed with which you will end up would be slow on an average. The correlations are very active in nature and they keep on changing every moment. The value of correlation for a past few days, if compared with the one of the last year will definitely show a lot of differences. For instance, pairs of currencies ‘A’ and ‘B’ have 0.98 as the correlation value from past a year. This clearly states that both of them go in similar directions and when ‘A’ moves up, ‘B’ also starts moving up quickly. However, after a month you find that the correlation value has changed to 0.10 and both of them are moving in similar direction, but with different speeds.
If two pairs of currencies go in the similar direction and have included correlation of a value more than 0.60 for the long-standing, the correlation value for past few days will become 0.20. According to this statistics, one can easily make a decision while trading in the market.