How to Trade Using a Forex Currency Strength Meter

One aspect of the Forex (FX) market that differentiates it from other financial markets is the concept of currency pairs. When you take a Forex position, you gain exposure to two different currencies. This creates many interesting opportunities, including the ability to measure one currency's strength against another.

However, It does make it complicated to judge the performance of a currency in isolation. Consider the Euro/US Dollar currency pair (EURUSD). If it has gained strongly on the day, is it because the EUR is doing well, or is it because the USD is performing poorly?

Using the Forex Currency Strength Meter in conjunction with support and resistance indicators, for example, can potentially yield better results as a more complete trading strategy.

This Forex indicator displays which currencies are strong and which are weak at any given moment, reflecting that movement in a matrix. By using an effective currency strength meter, you will have another tool at your disposal that will empower you to become a profitable trader.

Currency Strength Meter: An Introduction

So what is a currency strength meter, or a currency strength indicator?

Simply, a currency strength meter is a visual guide that demonstrates which currencies are currently strong, and which ones are weak. Currency strength indicators use the exchange rates of different currency pairs to produce an aggregate, comparable strength of each currency. Simple meters may not use any weighting, while more advanced ones may apply their own weightings. They may even combine other indicators with the currency strength measurement, to provide trading signals.

For example, to calculate the strength of the USD, the currency strength meter would calculate the strength of all pairs containing the USD (e.g. USDJPY, EURUSD, GBPUSD, AUDUSD, etc.) and then put those calculations together to determine the overall result for the US dollar.

A lesser known, but more comprehensive measure is the broad USD index, which uses a wider selection of currencies. Both work in a similar way. They calculate the strength of the Dollar by aggregating bilateral exchange rates into a single number, and then applying a weighting for the currencies included. The weighting applied for the broad index is a trade weighting, derived from trade data. Specifically, this is the share of merchandise imports in annual bilateral trade with the U.S.

Currency Strength Meter: Known Issues

Unfortunately, there are a number of issues when it comes to currency strength indicators - particularly when they are poorly coded. If a currency strength meter doesn't give accurate currency strength indicator values, it's of little use, regardless of its other features. With outdated currency strength meters, traders might experience:

1. MetaTrader 4 (MT4) freezes
2. PC freezes
3. Stutters
4. Whipsaw signals
5. Memory leakage
6. CPU working constantly at 100%

Some products might even produce data that's moved away from the original concept of what currency strength actually is. Some apply smoothing filters, like moving averages, while some apply other filters (e.g. RSI and MACD). By adding filters on top of demonstrating currency strength, traders might find themselves getting false trading signals, and could enter poor trades and that lead to a losing streak.

Instead, the real best way to measure currency strength is with currency correlation. If a Forex correlation matrix has been coded properly, using the latest technologies, it is unlikely to cause any of the aforementioned issues while having all of the same benefits as a currency strength meter.

Forex Correlation Matrix: The Real Currency Strength Meter

Over the years, Forex strength meters have naturally evolved into currency correlation matrices that can deliver more complex and accurate information. Forex correlation, like other correlations, signals correlation between two currency pairs.

In financial terms, 'correlation' is the numerical measure of the relationship between two variables (in this case, the variables are Forex pairs). The range of the correlation coefficient is between -1 and +1. A correlation of +1 indicates that two currency pairs will flow in the same direction. A correlation of -1 indicates that two currency pairs will move in the opposite direction 100% of the time. Finally, a correlation of zero denotes that the relationship between the currency pair is completely arbitrary.

When two currency pairs are strongly linked together, we say they have a high correlation.

When pairs move in the same direction, they have a positive correlation, and when they move in the opposite direction, we observe that they have a negative correlation. A perfect correlation occurs when pairs move in the same direction, which is extremely rare. We say that correlation is high when pairs move in almost the same direction.

How to you use currency correlation to calculate currency strength

Because currencies are traded in pairs (e.g. the EURUSD is the euro paired with the US dollar), we can use correlations to measure the strength of individual currencies.

For example, if the EURGBP and GBPUSD have a correlation of -91, this means they have a negative correlation - these pairs are likely to move in opposite directions, so two long trades (or two short trades) on these pairs would likely cancel each other out.

In the first pair, the GBP is the quote currency (meaning long trades expect the EUR to strengthen against the GBP). In the second pair, the GBP is the base currency (meaning long trades expect the GBP to strengthen against the USD). This means a long trade in the EURGBP is one that expects the GBP to weaken, while a long trade in the GBPUSD is one that expects the GBP to strengthen.

When it comes to currency strength, because there is such a high correlation between the two pairs, we can assume that the GBP (the common currency between the pairs) is the one that is driving these movements, and therefore the GBP is the strongest currency in this example.

Currency Strength: What are the Advantages?

There are a range of advantages to using a currency correlation matrix as a Forex strength indicator, including its simplicity, it's usefulness as a short-term indicator, the ability to eliminate double exposure and unnecessary hedging, the ability to signal high-risk trades, and the fact that it's available for free.

Useful, short-term currency strength indicator

Professional traders typically use FX strength meters as short-term indicators. They are useful as a quick guide to which currencies are on the rise, but are more of a snapshot of current strength than anything else, making them useful for immediate trading decisions (or to verify signals provided by other indicators).

Currency strength meters are simple

A major advantage of a Forex strength meter is how simple it is to understand. This is especially appealing for new traders - you don't need to be a Forex market expert, because you can just look at a simple graphical representation and see which currencies are faring well or performing poorly.

The Forex strength meter is available for free

If you want to try out a currency strength meter but are worried about investing in an expensive indicator, the good news is that you can get a free strength meter in Admiral Markets Supreme Edition plugin for MetaTrader 4 and 5!

MetaTrader Supreme Edition is a free MetaTrader plugin exclusively for traders with an Admiral Markets account. It includes an indicator package with 16 new indicators, including the Forex correlation matrix, which enables you to view and contrast various currency pairs in real-time.

Some other free features include the mini trading terminal, global sentiment widget, technical insight and Forex featured trading ideas provided by Trading Central. If you are feeling ready for all this and more, click the banner below to get started and start trading on the world's premier multi asset platform!

Correlation matrixes help eliminate double exposure

Assets with high correlation move in the same direction. For this reason, opening multiple positions with pairs that are highly correlated is not advisable, as you are essentially making the same trade more than once. This puts you in a very vulnerable position if the market turns against you. In Forex, if a trader goes long on the AUDCHF, AUDJPY, and EURJPY, a trader risks double exposure if they are highly correlated.

Digging deeper, the aforementioned positions bring double exposure to AUD and JPY, which can be harmful for trade should the movement go in the opposite direction from the trader's expectations.

With a Forex correlation matrix, you can see at a glance which currencies are correlated, which means you can avoid making these trades in the first place, and can consequently avoid double exposure to a weak currency.

Forex strength meters eliminate unintentional hedging

If the correlation strength between different pairs is known in advance, a trader can avoid unnecessary hedging. For example, if there is a negative correlation between EUR/USD and USD/CHF, you know that these pairs are moving in different directions. Therefore, if you opened long trades on both, you would likely win on one trade and lose on the other.

Again, knowing this up front helps prevent unintentional hedging.

Currency strength meters signal high-risk trades

Correlation between different currency pairs can also signal the level of trade strategy risk. For example, if we are going long on EUR/USD and GBPUSD, and both are positively correlated pairs, it signals a possible double risk from the same position if one of the currencies is strong.

What might also happen is that one of the pairs indicates a strong movement, while the other is just ranging, which signals traders to avoid entering trades with correlated pairs in the opposite direction. For example, if the EUR/USD is witnessing a downtrend, and the GBP/USD is ranging, a trader should avoid going long on GBP/USD, which carries a higher downside risk due to possible USD strength.

Currency Strength: How Does it Work?

The Admiral Markets Forex correlation matrix above shows the correlations between the following currency pairs:

• EURUSD - EUR to USD - Euro to United States Dollar
• EURCHF - EUR to CHF - Euro to Swiss Franc
• GBPUSD - GBP to USD - Great British Pound to United States Dollar
• GBPJPY - GBP to JPY - Great British Pound to Japanese Yen
• GBPNZD - GBP to NZD - Great British Pound to New Zealand Dollar
• USDCAD - USD to CAD - United States Dollar to Canadian Dollar
• EURCAD - EUR to CAD - Euro to Canadian Dollar
• USDJPY - USD to JPY - United States Dollar to Japanese Yen
• GBPAUD - GBP to AUD - Great British Pound to Australian Dollar
• GBPCHF - GBP to CHF - Great British Pound to Swiss Franc
• EURGBP - EUR to GBP - Euro to Great British Pound

Positively correlated pairs are those that move in a similar direction, while negatively/inversely correlated pairs tend to move in the opposite direction from each other. In the matrix above, correlations are also divided into four groups in accordance with their strength:

• Green: Little or no correlation
• Blue: Weak correlation
• Orange: Medium correlation
• Red: Strong correlation

This allows you to see at a glance how strong or weak different currencies are, with positive scores indicating strength, and negative scores indicating weakness. Here is what the data means:

• Positive Green: Little or no correlation. Positions on these symbols will tend to move independently and have profitability, which are not related to each other.
• Negative Green: Little or no correlation. Positions on these symbols will tend to move independently and have profitability, which are not related to each other.
• Positive Blue (up to +30): Weak correlation. Positions on these symbols will tend to move independently and have profitability, which are not related to each other.
• Positive Blue (up to +49): There may be similarity between positions on these symbols. Positions in the same direction may have similar profit. Positions in the opposite direction may offset each other.
• Negative Blue (up to -30): Weak correlation. Positions on these symbols will tend to move independently and have profitability, which are not related to each other.
• Negative Blue (up to -49): There may be similarity between positions on these symbols. Positions in the same direction may offset each other. Positions in the opposite direction may have similar profit.
• Positive Orange (up to +75): Medium positive correlation. Positions in the same direction on these symbols will tend to have similar profit. Positions in the opposite direction will tend to cancel each other out.
• Negative Orange: (up to -75): Medium negative correlation. Positions in the same direction on these symbols will tend to cancel each other out. Positions in the opposite direction will tend to have similar profit.
• Positive Red: (up to +100): Strong positive correlation. Positions in the same direction on these symbols are very likely to have similar profit. Positions in the opposite direction will cancel each other out.
• Negative Red: (up to -100): Strong negative correlation. Positions in the same direction on these symbols are very likely to cancel each other out. Positions in the opposite direction will have similar profit.

In the image above, we can see that the CAD is the strongest currency, as it shows a +91 correlation between the USDCAD and the EURCAD. The weakest correlation is between EURGBP and GBPCHF at -96, which means that the simultaneous positions in this pair within the same direction are very likely to cancel each other out. In terms of currency strength, this indicates GBP strength and that the Swiss Franc is the weakest currency.

As you can see, It's a relatively simple concept that allows you to judge the raw strength of a currency in isolation, as opposed to seeing what it is doing against another currency.

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Can currency correlations change?

While correlations do exist, it's also important to recognize that these can change. Global economic factors are dynamic – they can and do change on a daily basis. Correlations between two currency pairs may vary over time, and as a result, a short-term correlation might contradict the projected long-term correlation.

Looking at correlations over the long term provides a clearer picture about the relationship between two currency pairs – this tends to be a more precise and definitive data point.

This is why it's important to regularly calculate correlations, and why a tool like the MetaTrader Supreme Edition correlation matrix is so helpful - it is constantly updating correlations in real time.

How to Download a Currency Strength Meter

One of the best available currency strength meters is the correlation matrix included in the MetaTrader Supreme Edition plugin for MetaTrader 4 and 5.

MT4 and MT5 are the world's most popular FX trading platforms. One of their advantages is the ability to download and use custom indicators together with Expert Advisors (EAs). While both platforms comes with a useful selection of popular indicators built into the client terminal, you can also download independently written custom indicators.

As MT4 is an open platform and has such a wide community of users that indicator innovations move fast. You can search for both free and paid custom indicators from within the platform.

MetaTrader Supreme Edition is a free plugin that includes a currency correlation matrix, as well as other custom indicators and a live trading simulator to backtest strategies. It also allows you to add different custom indicators and EAs you might benefit from.

To download and install MetaTrader Supreme Edition, just follow these steps:

1. Sign up for a live or demo trading account.
2. Download and install MetaTrader 4 or MetaTrader 5.
3. Download and install MetaTrader Supreme Edition.
4. Open MetaTrader on your computer and sign in using your trading account details.
5. You will see a list of the MetaTrader Supreme Edition tools in the Navigator window under Expert Advisors.

As you can see, having the right platform and a trusted broker are hugely important aspects of trading. Admiral Markets is an award-winning broker that offers the ability to trade on the Forex market, to trade with CFDs, to invest in stocks and ETFs and much more. This is all made possible with MetaTrader Supreme Edition.

How to Use the Currency Strength Meter

Once you've installed MetaTrader Supreme Edition, you can use the Forex correlation matrix by following these steps:

1. In the Navigator window, expand the Expert Advisors menu.
2. Double click 'Admiral - Correlation Matrix', or drag it on to an open currency chart.
3. Set any custom parameters in the popup window.
4. Click 'OK' to open the matrix.

When it comes to using the correlation matrix – the true strength currency meter uses complex algorithms, but is very easy to use. It even allows you to choose a strength for a certain period of time. For intraday trading, it is typically recommended to use up to 200 bars, while for scalping, up to 50 bars should be enough.

As a general rule, start with the following intervals for different trading time frames:

• Scalping: M5 - 50 bars
• Intraday trading: H1 - 200 bars
• Intraweek swing trading: H1 - 500 bars or H4 - 200 bars

Currency Strength: Maximizing its Use

Bear in mind that correlations do change, and past performance is not always a guaranteed indicator of future correlations. However, this information can be used to develop your own currency strength strategy, and to minimize your portfolio's exposure. Here are some tips to consider:

• Avoid positions that cancel each other out: If you see two currency pairs that move in opposite directions nearly all of the time, you should realize that holding long positions in both of those currencies mitigates any potential gain that could be had.
• Diversify with minimal risk: By investing in two currency pairs that are almost always positively correlated, one can mitigate risks over time, while maintaining a positive directional view.
• Hedge exposure: Losses can be minimized by hedging two currency pairs that hold a near-perfect negative correlation. The reasoning here is simple. If you hold a position with a currency pair that loses value, the opposing currency (which has a negative correlation to that pair) will likely gain, albeit with a lower final value. While such a strategy won't completely mitigate losses, those losses will very likely be reduced.

Finally, as with any technical tool or indicator, there are weaknesses to the Forex correlation matrix as well. One is that the currency strength indicator only communicates a very narrow piece of information. Therefore, it is worth considering how currency strength and weakness fit into the bigger picture.

This big picture includes:

• Are there fundamental reasons that support the currency meter's story?
• Does the currency meter accurately tell the story like other indicators?
• Will the trend continue?

As you can see, like most technical tools, currency strength meters are more useful when used in conjunction with other indicators. For example, you might want to use a strength meter to complement or confirm what other signals are saying.

The image above displays the GBPJPY chart, with a Relative Strength Index (RSI) indicator applied. The RSI attempts to identify when an instrument is oversold or undersold. By comparing this information to the information shared in a currency strength meter, you will get a deeper sense of a currency's strength, and it's potential to strengthen or weaken.

Finally, if you do decide to try out a currency strength meter, it's a good idea to test it in a risk-free trading environment. Why not try experimenting with real-time market prices in our free Forex demo trading account, and see how well it works for you? Practice now by clicking the banner below:

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