Understanding Currency Correlations

What is correlation? 

Before going deeply into currency correlation, there is a need to explain what correlation means. correlation is a statistical measure of how two securities/ assets move in relation to each other. 

Correlation is expressed by the correlation coefficient with a value between -1 and 1. A correlation coefficient of -1 reflects a perfect negative correlation, which simply means that, if one variable rises, the other variable will fall to the same extent.  

A correlation coefficient of 1 is a perfect positive correlation, which means that, if one variable rises, the other will follow in equal measure.  

Finally, a correlation coefficient of 0 signals that there exists no meaningful statistical relationship between the two variables, i.e., they do not correlate in any way and move completely independently of one another. 

In summary, correlation coefficient of -1 variables move in opposite directions, +1 variables move in the same direction, 0  has no significant relationship existing between the two variables. 

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         Positive coefficient         Negative coefficient    Zero coefficient  

Figure 1.1 Correlation coefficient  

What is Currency Correlation? 

There are many techniques that Forex traders can use to trade the market and improve their trading strategy. This is an important strategy that can be use by traders who trade more than one pair of currency or such trader want to build a portfolio of trades, in which forex correlation can help reduce market risk and increase profit. In this article, I’ll cover everything you need to know about currency correlation. Currency correlation, tells us whether two currency pairs move in the same, opposite, or totally random direction, over some period of time 

How to calculate a simple currency correlation using Excel  

Step 1: open the Excel sheet  

Step 2: Copy and paste your data into an empty spreadsheet 

Step 3: arrange your data by using the font and style of yours  

Step 4: you decide on a time frame you want to use. 

Step 5: In the first empty cell below write your first comparison pair i.e. are you correlating with EUR/ USD to the other pair (EUR/USD and USD/JPY) type: =correl( 

Step 6: Next, select the range of cells for EUR/USD’s price data, followed by a comma. 

Step 7: After the comma, select USD/JPY’s price data range just like you did for EUR/USD. 

Step 8: Click the Enter key on your keyboard to calculate the correlation coefficient for EUR/USD and USD/JPY. 

Step 9 : Repeat Steps 4-8 for the other pairs and for other time frames. 

Type of correlation  

In the Forex market, we can identify three types of correlation: 

  • Correlation between individual currencies 

One of the most basic correlation types that any Forex trader should understand is between currencies. Two individual currencies can exhibit a certain correlation due to their specific fundamental characteristics. Some of the  currencies use in trading on forex market  tend to move in tandem while others move in opposite directions. 

With all the different currencies that is use to trade o there on the forex market  

  • Correlation between currency pairs 

 Forex traders often use Forex correlation matrix tables to analyze the correlations between various currency pairs. Since currencies are always quoted in pairs, it makes perfect sense to follow the correlation coefficients among pairs to trade the market and take advantage of their correlation. 

  • Correlation based on macroeconomic (news) releases 

Correlations can also be calculated for the impact of news releases on certain currencies. Forex traders who use a news trading strategy can benefit from this a lot; since these correlations tell how certain currencies behave after an important macroeconomic (or news) release is published. 

CONCLUSION  

If you take multiple positions when trading, knowing how your pairs act in relation to one another is key to understanding your real risk and profit potential.