Everything is interrelated in the forex markets. It is important for you to understand that the price action of each currency pair is not mutually exclusive.
Different currency pairs move relative to one another. You need to understand that different currency pairs are correlated. Correlation can be positive or negative.
Knowing how strong this relationship is and its direction can help you a lot in developing your trading strategies. Correlation analysis has the potential to become a great trading tool for you.
Correlations are numbers that range between +1 and -1. These numbers are calculated based on past pricing data between different currency pairs. They can provide you with information that can maximize returns, minimize risk and avoid counter productive trading.
Lets use an example to make it clear. Suppose USDJPY and USDCHF has a positive correlation of +0.83 last month. This number is close to +1. It indicates that both pairs move together most of the time in the same direction.
Now, if you are trading USDJPY and USDCHF at the same time, it will double up your position if you take long positions or short positions on both at the same time. If you lose a trade on USDJPY, the chances are that you will also lose the trade on USDCHF 83% of the times.
Lets take another example. EUR/USD and USD/CHF both have a negative correlation of -0.9 in the last month. It means both the pairs were moving in opposite directions last month. If you take long position on one, it is not a good strategy to take short position on the other. It will only double up your position again and increase risk.
When investing in two pairs at the same time, try to choose such pairs that have correlations close to zero. This will make the two pairs almost independent of each other and you can invest in both of them safely.
Dont forget that currency markets are constantly changing. The correlations between pairs also keep on changing. It would be good to calculate the correlation numbers between pairs on a monthly basis.
|
|