Forex correlation is a critical thing. Many traders even don’t think about it. Correlation shows us three things:
1. How similar currency pairs move in the same way
2. How different move in opposite ways.
3. Currencies don’t move in the same way or different ways. That means there is no correlation.
To use correlation, we need at least two pairs. You have to follow forex correlation if you want to trade more than one pair. In my trading system correlation is the part of risk management.
For example, I have an open trade with EURUSD and I look for another deal, let’s say to the USDCHF. Let’s now see how these two pairs correlate with each other. We can see that daily correlation is -92.3 it is a very high correlation, and it means that pairs go very similar in an opposite way. So you shouldn’t open second trade with USDCHF because it moves to the same opposite way. So if you have opened a position with EURUSD and later with USDCHF and you think that you have diversified your portfolio – you are wrong, you just doubled your risk, not diversified.
One more the important thing is that correlation is not constant, so if you are a scalper, you should use 5min -1hour correlation, if you are a day trader use 1 hour and one day if you are a swing trader – 1 day and one week.
I am always using correlation.
You don’t have to count it manually; it can be done for you. I have seen many situations when the day trader has active trades with EURUSD, GBPUSD, AUDUSD. If you look at 1-hour correlation, it goes in the same way.
Keep in mind that using correlation can help you to avoid losses, I want to say that it can help you not to double or triple your risk.
Let‘s look at an example about EURUSD and USDCHF charts. We can see the similar opposite movement; we even don‘t need to count correlation. Today you can easily compare two or more pairs in your charting software on one chart, just open EURUSD chart and you can overlay USDCHF chart on it.
In my opinion, if you want to have more than one active trade, check correlations between currency pairs you are interested in. Of course, do it before opening your second trade.
As I noticed above correlation is a part of risk management. Keep in mind that correlation is not constant, it changes sometimes. As the economy is very, dynamic correlation can change drastically. To watch correlation you can use many free sites, you just need to select pairs, and it will be done for you. One more thing, you can count it by yourself manually, just for example, use Excel, but you have to download the data of these pairs. Just use Excel function – =correl.
As I mention forex correlation can be a part of your risk management that means if you have EURUSD, and see next excellent opportunity with another pair with USD or EUR, you can watch correlation and see if it is worthy to open another trade.
One more thing, keep in mind that correlation between pairs may change, that means that the correlation can increase, decrease or even disappear.