How to Trade Forex Correlations
You may often hear that the financial markets are correlated. What does this mean? Forex correlations measure how two different currency pairs move in relation to one another.
When one currency pair is moving higher there is often another currency pair that is negatively correlated and moving in the opposite direction.
Having a grasp on forex pair correlations is essential for portfolio and risk management. In this ‘How to Trade Forex Correlations’ article, we explore the concept of forex currency correlations and how to access a free currency correlation matrix indicator.
Table of Contents
What is Forex Correlation?
What is forex correlation? A forex correlation is when two different currency pairs have a positive or negative directional relationship between them.
- A positive correlation means that there are two currency pairs moving in the same direction as one another.
- A negative correlation means that there are two currency pairs that are moving in opposite directions of one another.
Understanding how currency pairs are correlated is important to manage the risk of your overall trading account to make sure you are not too heavily exposed to one direction of the market.
Some traders will also use currency correlation to hedging strategies to manage the risk of their portfolio.
How to Use a Currency Correlation Matrix Indicator
With Admiral Markets, you can upgrade your MetaTrader 5 trading platform with the Supreme Edition plugin for free. This plugin comes with a wide range of additional indicators and tools to supercharge your trading experience.
One of these indicators is the Currency Correlation Matrix as shown below.
With the correlation matrix provided in the MetaTrader Supreme Edition upgrade from Admiral Markets, you can view the correlation between a wide range of:
- Currency pairs, cryptocurrencies, stock indices and commodities
- Time periods (weekly, daily, 4-hour, 1-hour, 30-minute, 15-minute, 5-minute and 1-minute charts)
- Bars (the last 25, 50, 100, 200, 300, 500 or 1,000 bars)
The data is then colour coded:
- Green boxes = No correlation (0 to +/- 25)
- Blue boxes = Weak correlation (+/- 25 to +/- 50)
- Orange = Medium correlation (+/- 50 to +/- 75)
- Red = Strong correlation (+/- 75 to +/- 100)
What do the + and – signs mean?
- + values mean that both instruments being analysed have a positive correlation and are moving in the same direction
- - values mean that both instruments being analysed have a negative correlation and are moving in opposite directions
Download the Currency Correlation Matrix indicator for free from the Admiral Markets MetaTrader Supreme Edition plugin.
How to Read Forex Correlation
Understanding USD Forex Correlations
From the forex correlation table above, at the time of writing it shows GBPUSD and EURUSD with a +93 value in a red box. So what does this mean?
We know that a red box means that there is a strong correlation. And the + value means there is a positive correlation.
This means that both pairs are highly correlated and are generally moving in the same direction. This may seem evident as both have USD as the terms currency so when either of the exchange rates rise it is showing US dollar weakness.
In the forex correlation matrix window above, the GBPUSD and USDJPY currency pair is also in a red box but has a value of –95. This means that both pairs are highly correlated but have a negative correlation.
This is evident as if GBPUSD rises in value it is showing USD weakness. When USDJPY falls in value it is showing USD weakness. So they both have a high currency correlation but in opposite directions.
Forex correlations of the US dollar may seem evident at first. However, knowing the correlations between other cross-rate currency pairs and asset classes is very difficult if not using the correlation matrix.
Understanding Forex Cross-Rate & Cross-Asset Correlations
From the forex currency correlations table above, it shows EURCAD and the DAX (GERMANY 40) stock index with a +77 value in a red box. This means that this currency pair and stock market index have a very high positive correlation and have been generally moving in the same direction.
These are two completely different asset classes which have a strong positive correlation. Why is this important to know? Well, a trader could easily trade EURCAD and the DAX (GERMANY 40) stock index long thinking they are unrelated.
However, as they have a positive correlation if one of the market turns the other away then there is a chance they could both turn the other away. This effectively means the trader is risking more of their trading account and markets that tend to move in the same direction which could cause large losses.
Another example would be EURGBP and NZDCHF which – at the time of writing – has a value of –78 in a red box. This means these two currency pairs have a strong negative correlation. When one currency pair is moving higher the other currency pair is moving lower.
How to Trade Forex Correlations
There are a variety of ways to use the date from forex currency correlations. Some traders may choose to trade positive correlated markets but split up their risk across different currency pairs as a form of diversification.
For example, if you are bullish on the USD then instead of buying just USDJPY, traders may look for other positively correlated markets to the US dollar and split up the risk across them. If one market turns the other way the diversification into other markets can help to maintain the initial traders’ bias.
Another way to use forex correlations is to make sure that the positions on your trading account have a weak or no correlation at all. This way there is no over exposure to correlated currency pairs moving in the same direction.
You can also use forex correlations for forex hedging. If you are long one currency pair, a trader may take an opposite position on a negatively correlated currency pair. As one trade moves in a loss the other trade (theoretically) may move into a profit as the currency pairs chosen have a negative correlation.
It’s worthwhile pointing out that correlations will come and go and change over time. Therefore, always make sure to stay on top of the current forex pair correlations happening in the market and focus on risk management first and foremost.
Download the Currency Correlation Matrix Free
- Open a live account or a free demo practice trading account.
- Download the MetaTrader Supreme Edition platform.
- Open the Navigator window in MetaTrader and double click Admiral – Correlation Matrix
- Input the currency pairs, commodities or stock indices to analyse, as well as the timeframe
- Start reading the forex correlation table!
FAQs on Forex Correlations
What is forex correlation?
Forex correlation is the analysis of two different currency pairs and how correlated they are. A positive correlation means they tend to move in the same direction. A negative correlation means they tend to move in opposite directions.
What is an example of currency correlation?
Forex correlations change over time. However, USD-pairs tend to be correlated with one another as the US dollar is the world’s largest currency. For example, EURUSD and GBPUSD have a strong correlation with one another.
What is an example of currency correlation?
EURUSD and GBPUSD tend to have a positive correlation. As the USD is the terms currency, when both currency pairs rise the US dollar is weakening. When both currency pairs fall, the USD is strengthening.
INFORMATION ABOUT ANALYTICAL MATERIALS:
The given data provides additional information regarding all analysis, estimates, prognosis, forecasts, market reviews, weekly outlooks or other similar assessments or information (hereinafter “Analysis”) published on the websites of Admiral Markets investment firms operating under the Admiral Markets trademark (hereinafter “Admiral Markets”). Before making any investment decisions please pay close attention to the following:
1. This is a marketing communication. The content is published for informative purposes only and is in no way to be construed as investment advice or recommendation. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead of the dissemination of investment research.
2. Any investment decision is made by each client alone whereas Admiral Markets shall not be responsible for any loss or damage arising from any such decision, whether or not based on the content.
3. With view to protecting the interests of our clients and the objectivity of the Analysis, Admiral Markets has established relevant internal procedures for prevention and management of conflicts of interest.
4. The Analysis is prepared by an independent analyst, Jitanchandra Solanki, (hereinafter “Author”) based on personal estimations.
5. Whilst every reasonable effort is taken to ensure that all sources of the content are reliable and that all information is presented, as much as possible, in an understandable, timely, precise and complete manner, Admiral Markets does not guarantee the accuracy or completeness of any information contained within the Analysis.
6. Any kind of past or modelled performance of financial instruments indicated within the content should not be construed as an express or implied promise, guarantee or implication by Admiral Markets for any future performance. The value of the financial instrument may both increase and decrease and the preservation of the asset value is not guaranteed.
7. Leveraged products (including contracts for difference) are speculative in nature and may result in losses or profit. Before you start trading, please ensure that you fully understand the risks involved.
