Trading currency correlations

A foreign exchange correlation is the connection between two currency pairs. There is a positive correlation when two pairs move in the same direction, a negative correlation when they move in opposite directions, and no correlation if the pairs move randomly with no detectable relationship. A negative correlation can also be called an inverse correlation.

Currency correlation is important for traders to understand because it can have a direct impact on forex trading​ results, often without the trader’s awareness.

As an example, assume that a trader buys two different currency pairs that are negatively correlated. The gains in one may be offset by losses in the other, which is often used as a hedging strategy. Meanwhile, buying two correlated pairs may double the risk and profit potential, since both trades will result in a loss or profit. They are not fully independent since the pairs move in the same direction.

A correlation coefficient represents how strong or weak a correlation is between two forex pairs. Correlation coefficients are expressed in values and can range from -100 to 100, or -1 to 1, with the decimal representing the coefficient.

Anything in the negative range of -100 means that the pairs move nearly identically but in opposite directions, whereas, if it is above 100, it means that the pairs move nearly identically in the same direction. “Nearly identically” is an important distinction to make because correlation only looks at direction but not magnitude. For example, one pair may move up 100 pips (percentages in point)​ while another moves down 70 pips. Both pairs may have a very high inverse correlation, even though the size of the movement is different.

If a reading is below -70 and above 70, it is considered to have strong correlation, as the movements of one are largely reflected in movements of the other. Readings anywhere between -70 and 70, on the other hand, mean that the pairs are less correlated. With forex correlation coefficients near the zero mark, both pairs are showing little or no detectable relationship with one another.

The following table shows the correlation between some of the most traded currency pairs​​ across the world. You can compare each currency on the y-axis to those on the x-axis to see how they are correlated to one another. For instance, the correlation between the EUR/USD​​ and GBP/USD​​ is 77, which is quite high.

Currency pairs are non-correlated when they move independent of each other. This can happen when the currencies involved in each pair are different, or when the currencies involved have different economies.

For example, the EUR/USD and GBP/USD both contain the US dollar, and the Eurozone and Great Britain are in close proximity with closely tied economies. Therefore, they tend to move together in the same direction, although this is not always the case, as we will see further on in the article. Meanwhile, the EUR/JPY and AUD/USD have no matching currencies. In fact, the Eurozone, Japan, Australia and the US all have distinct and separate economies. Therefore, the correlation between these pairs tends to be lower.

There are many ways that correlations can be used as part of a forex trading strategy​​, such as through hedging, pairs trading and commodity correlations. To start trading forex correlations pairs, all you need to do is the follow the below steps:

While a number of currency correlation strategies have been discussed in this article, using them on a trading system means defining exact entry and exit points, both for winning and losing trades. Next Generation is an award-winning forex trading platform​​* that allows you to view and trade forex correlations in real time.

On our platform, any currency can be dragged from the product list onto an existing chart of any currency pair to show both currency pairs on the same chart. The following chart compares the EUR/USD (candlestick) with the GBP/USD (line). These pairs typically move together, but in this example, they moved in opposite directions. This set up is a potential mean-reversion trade.