Suppose you have the data for the currency correlations of the major pairs. The correlation between GBP/USD and EUR/USD is 0.68. It means that both the pairs move in the same direction 68% of the time.
USD/CHF and EUR/USD have a correlation coefficient of -0.975 and is pretty close to (-1). It means both USD/CHF and EUR/USD pairs move in the opposite direction almost 97.5% of the time. It means if USD/CHF moves up, the pair EUR/USD will move down!
You have this information. It tells you how much these pairs move in the same or opposite directions. Suppose you trade both the pairs USD/CHF and EUR/USD by going long at the same time. What you will be doing is in fact canceling both the positions.
If you win on USD/CHF, you will lose on EUR/USD and vice versa. The two trades would effectively cancel each other due to the negative correlation between the two pairs. A savvy investor would go long on USD/CHF and go short on EUR/USD. So you are shorting USD in both the trades and diversifying the USD bearish investment.
Currency correlations can help you in making entry and exit decisions for each trade. Lets suppose GBP/USD starts showing volatility. The pair approaches a resistance level. You plan on going long if there is a breakout.
However, you notice on the charts that the other three major currency pairs are not showing volatility and moving as much as the GBP/USD. EUR/USD is not showing volatility and moving up on the chart. USD/CHF is not showing much volatility and moving down on the chart. USD/JPY is also not showing much volatility and not moving down on the chart. This means that the volatility in GBP/USD is solely GBP driven. The move is maybe related to some news in the British economy about Bank of England raising or lowering interest rates or some big companies merging.
You know now that the move in GBP/USD pair is GBP driven. The move is not US Dollar driven. You have isolated the cause of movement in GBP/USD pair and can take advantage of this information. Ignore the GBP driven move. Dont enter into any trade. Wait for a later opportunity. An opportunity that involves simultaneous correlated moves of all the major pairs!
Take another example. Suppose you have entered a short EUR/USD trade. You want to know whether the pair will either proceed down towards your profit target or go against you and cause you to exit the trade with a small loss.
Your EUR/USD is heading towards M1 level after having broken the S1 support pivot level. You should take a look at the pair EUR/GBP. You find that it has paused at its S1 support pivot level. It is showing signs of reversing to the upside.
Knowledge of currency correlations can help you a lot now. It can tell you if EUR/GBP breaks through the S1 level, you are poised for a profitable trade in this type of a situation, However, you should watch the indicators. Exit before taking a big loss if EUR/GBP reverses and heads back to the upside. You might consider trading a basket of all the major currencies as you mature in forex trading.
USD/CHF and EUR/USD have a correlation coefficient of -0.975 and is pretty close to (-1). It means both USD/CHF and EUR/USD pairs move in the opposite direction almost 97.5% of the time. It means if USD/CHF moves up, the pair EUR/USD will move down!
You have this information. It tells you how much these pairs move in the same or opposite directions. Suppose you trade both the pairs USD/CHF and EUR/USD by going long at the same time. What you will be doing is in fact canceling both the positions.
If you win on USD/CHF, you will lose on EUR/USD and vice versa. The two trades would effectively cancel each other due to the negative correlation between the two pairs. A savvy investor would go long on USD/CHF and go short on EUR/USD. So you are shorting USD in both the trades and diversifying the USD bearish investment.
Currency correlations can help you in making entry and exit decisions for each trade. Lets suppose GBP/USD starts showing volatility. The pair approaches a resistance level. You plan on going long if there is a breakout.
However, you notice on the charts that the other three major currency pairs are not showing volatility and moving as much as the GBP/USD. EUR/USD is not showing volatility and moving up on the chart. USD/CHF is not showing much volatility and moving down on the chart. USD/JPY is also not showing much volatility and not moving down on the chart. This means that the volatility in GBP/USD is solely GBP driven. The move is maybe related to some news in the British economy about Bank of England raising or lowering interest rates or some big companies merging.
You know now that the move in GBP/USD pair is GBP driven. The move is not US Dollar driven. You have isolated the cause of movement in GBP/USD pair and can take advantage of this information. Ignore the GBP driven move. Dont enter into any trade. Wait for a later opportunity. An opportunity that involves simultaneous correlated moves of all the major pairs!
Take another example. Suppose you have entered a short EUR/USD trade. You want to know whether the pair will either proceed down towards your profit target or go against you and cause you to exit the trade with a small loss.
Your EUR/USD is heading towards M1 level after having broken the S1 support pivot level. You should take a look at the pair EUR/GBP. You find that it has paused at its S1 support pivot level. It is showing signs of reversing to the upside.
Knowledge of currency correlations can help you a lot now. It can tell you if EUR/GBP breaks through the S1 level, you are poised for a profitable trade in this type of a situation, However, you should watch the indicators. Exit before taking a big loss if EUR/GBP reverses and heads back to the upside. You might consider trading a basket of all the major currencies as you mature in forex trading.
About the Author:
Mr. Ahmad Hassam is a Harvard University Graduate. He is interested in day trading stocks and currencies. Know These Forex Broker Games. Learn Forex Trading!
Posts
No comments:
Post a Comment