Currency Correlation Explained

Currency Correlation Explained

Have you ever mentioned that when a particular currency pair rises, another currency pair falls? Or how about when that same currency pair falls, another currency pair seems to copy it and drop also?

•    If the answer is “Yes” you have just witnessed currency correlation in action.

•    If you answered is “No”, do not worry, because we are going to start with the basics and break it down.

Correlation:

Correlation means a relationship between two things.

Currency Correlation:

In the financial world, correlation is a statistical measure of how two securities move about each other.

Currency Correlation then tells us whether the two currency pairs move in the same, opposite, or totally random direction, over a period.

When the trading currencies, it is important to remember that since currencies are traded in a pair, that no single currency pair is ever totally isolated.

Unless you plan on trading just one pair at a time, it is crucial that you understand how different the currency pairs move in relation to each other, especially if you are not familiar with how the currency correlations can affect to amount of risk you are exposing your trading account too.

If you do not know what the heck you are doing when the multiple trading pairs simultaneously in your trading account, you can get  Murdered! Killed! Destroyed! I can’t stress this enough.

In this lesson, you will learn about what currency correlation is and how to use it to help you become the smarter trader and make more efficient for risk management decisions.

Currency Correlation Coefficient:

Correlation is estimated into what is known as the correlation coefficient, which ranges between the -1 and +1.

1. A Perfect positive correlation (coefficient of +1) means that the two currency pairs move in the same direction 100% of the time.

2. A Perfect negative correlation (coefficient of -1) means that the two currency pairs move in the opposite direction 100% of the time.

3. If the correlation is 0, the movements between the two currency pairs are said to have ZERO or NO correlation, and they are totally independent and random from each other. We have no idea how the one pair will move about the other.