Currency Correlations – is one of the important concepts of Forex trading that should be in the arsenal of every trader, which is trading on currency and other financial market. What is currency and other financial instruments correlation? In fact, the correlation is the relationship between various assets in which the change in the dynamics of one asset affects another’s state.
This relationship in the Forex market is measured by so-called correlation coefficient, which values are in the range from -1 to +1. Minus one index is opposite, mirror movement of the two assets, plus one factor involves the movement of assets in the same direction at the same time. The coefficient 0 is the lack of any correlation, and therefore there is no correlation between assets. Intermediate coefficient values that are in the range of from +0.1 to +0.9 means that trading instruments go by not equal 100% but as the ratio closer to zero, so the contact is weaker.
There is a specific formula for correlation between financial and monetary instruments calculation. The formula is relatively complicated and the correlation calculation between two instruments may be difficult, though often for these functions the features of Excel software is used. But to use special calculators is still easier. The latter option is more convenient and it is implemented in certain financial projects, one of which is the site of Oanda U.S. Forex broker. The image below contains a table with the calculated correlation coefficients for main currency pair from 1 hour to 1 year. There you can find information about how to use the table as well as the formula for coefficients’ calculation.
After clicking on the asset interested in the left column, the table displays coefficients’ values with other currencies in the form of symbol circles, color and size of which corresponds to the strength of pair relationships.
Certainly, you do not just notice that the graphs of some currency pairs move virtually identical or graphics are drawn in mirror. For example, EURUSD and GBPUSD have a correlation coefficient approximate to 1, which means that often they move in the same direction. Below you can see how the motion of one instrument repeats, albeit not by 100% another instrument’s movement.
What is the reason? The reason is that the correlation coefficient is not a statistical indicator, it changes depending on various conditions. And if this week two instruments were going practically in the same direction, next week they can go in different directions, drawing mirrored charts. Therefore, the trader should follow currencies’ correlation coefficient as often as possible, taking into account their changes on the tradable time frame and given their opening trades.
There are market and non-market factors that affect any particular currency. So, the euro is affected by European countries’ policies, mainly German. As EURUSD is leading currency pair and the change in the price of all pairs will depend on the policy of the Eurozone.
As GBP, its movement primarily depends on interest rate size in the UK. As they are higher, so the price of the instrument is higher too.
Logic of related financial instrument movement can be used in commercial processes used and in certain strategies. For example, if several pairs with positive correlation to each other are increasing at the same time (EURUSD is increasing, so EURJPY and EURGBP currency pairs with a positive correlation are also increasing), so it amplifies purchase signal for any of considered tools.
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