Can a more experienced trader help me with a question. I have never paid attention to the positive or negative correlation numbers before today. I just setup an account with the books and going through the site, came upon the charts with the currency correlation figures. My question is this: would a trader want to pay more attention to negative correlations between the pairs because (as I think I understand the meaning) they would be moving in opposite directions. After all, isn't that what we are trading, one currency strengthening and the other weakening? Thanking you advance, JK
What you are trading is one data set against another. Regardless of what the data comprises of.
Wether it's a positive correlation or a negative correlation is irrelevant. What you have is a calculable relationship. A strategy for example would be to look for a break down in correlation on the short term and then trade towards the long term correlation.
EurUsd vs GbpUsd for example. They're normally about 80% correlated on weekly. So lets say EurUsd goes down and GbpUsd stays flat (which is a break down in correlation) then you'd buy EurUsd and sell GbpUsd. It might go to a temporary negative correlation in such a case on a lower time frame.
Of course that gives you a EurGbp position. But to me it's a better method than technical analysis. It's calculable.
If it was EurUsd vs UsdChf, strong negative correlation, you'd just buy both or sell both on short term breakdown in correlation.
Problem is every now and then correlations break down completely for long periods of time, especially in this type of market where prices are heavily and openly manipulated. But as with any type of system you can come up with account protection methods, like stop outs on NAV losses, trade size reductions if you detect a series of failures etc...
Another way of doing it is to simply overlay highly correlated pairs on chart, then it will become obvious where to trade and in which direction, but the position will always consist of two trades. You trade both pairs and regard it as one position.
Thanks Hand for the explanation. It willl take awhile for that to sink in. I did not come away understanding it that way. The sites definition doesn't say anything about the comparison between four currencies(two pairs). If I remember correctly even the chart just shows one pair. Thx again for responding
For something to be correlated you need two data sets. The correlation is one figure, sure. But you still need to compare something to something.
In fx the data set is made up by 2 pairs. So to compare 1 set to another you are using four currencies.
Easier way to see that in action is to open a Oanda demo account, do the trades and look at the exposure tab. MT only recently added that to their platform, but go do the trades and see what happens to exposure.
The devil is in the details with fx. This is a fundamental principle of fx. It needs to be understood if you're going to trade fx.
Currency correlations or forex correlations are a statistical measure of the extent that currency pairs are related in value and will move together. If two currency pairs go up at the same time, this represents a positive correlation, while if one appreciates and the other depreciates, this is a negative correlation.