Which currency pairs are correlated in the Forex market?
Have you ever thought about which currency pairs are correlated nowadays? Are you familiar with the term “Forex correlation” in general? And ultimately, why is it so crucial to know if you are into foreign exchange and trading accounts?
In the world of finance, correlation represents the relationship between the assets. Learning more about correlation table and correlated Forex pairs will save you time in finding the ideal pair to trade and reach profits and success in the volatile Forex market faster.
In this article, you’ll learn what currency correlation is in Forex trading, which currency pairs are highly correlated, and how to take advantage of it in Forex trading! But before doing so, let’s find out what correlation means, shall we?
What is correlation exactly?
In finance, correlation refers to the statistical measure of the relationship between two securities, such as currency pairs. The correlation coefficient is a numerical value that ranges from -1.0 to +1.0 and helps traders understand how the price of one currency pair may impact another.
If two certain currency pairs have a correlation coefficient of +1, they will always move in the same direction. On the other hand, a correlation coefficient of -1 shows us that the two currency pairs will move in opposite directions 100% of the time. A correlation coefficient of zero implies that the two currency pairs possess no discernible connections, pattern, or trend; they are essentially random.
Correlation coefficient range
The correlation between the currency pairs can be positive and negative, and the correlation coefficient measures it. But how does one determine which currency pairs are correlated, and to what extent? The correlation coefficient between the two currencies can go from -1 to +1. It can also sometimes be expressed as -100 to +100.
When the correlation is +1, that means that the two pairs are going in the same direction 100% of the time. On the other hand, if the correlation coefficient is -1, the two pairs are always going in two opposite directions.
The coefficient of 0 means that pairs don’t have any correlation between them. The span of -1 to +1 represents a wiggle room for degrees of correlation. If it is above 70 per cent in a positive or negative direction, we can say the currencies don’t move the same way. If they are below 60, then there is no correlation.
Commodities related to currency pairs
Currency pairs correlate with each other. But they can also correlate with commodities. That’s because some commodities have an important place in some countries economies. For example, Australia is number 2 in the world ranking of gold-producing countries.
So this commodity greatly influences the country’s economy, and the AUD/USD pair correlates with the evolution of the gold price.
Regarding oil, Canada is a country that has significant oil production. Suddenly, the price of oil will influence the USD/CAD pair. You should also know that correlation coefficients are not static numbers. On the contrary, it’s something very, very dynamic.
How to implement the correlation in Forex trade
Before knowing which currency pairs are correlated in the market, it’s crucial to note one thing first: If trading particular currency pairs based on correlation interests you. Here are the two ways of doing it the best:
- The two pairs are in correlation:
If two currency pairs are correlated, that means they are moving at the same time in the same direction. But you have no strategic interest in simultaneously taking a position on both pairs. So, you could wait and take new positions on only one of the two currency pairs. It’s called pyramiding, and at the strategic level, it’s beneficial.
- The two pairs are not in correlation:
This can be an excellent opportunity if you want to invest your money in each of the two pairs.
On the other hand, always be careful and wait for the right time to do so, for example, when your first position is under hedging.
Strongest positive correlation currency pairs
Let’s see which currency pairs are correlated in a positive direction. Those are usually currencies of tightly linked economies. Take, for example, the economy of the UK, the Japanese economy, and the US economy. The combination of these currencies results in the strongest correlated currency trading pairs.
Or let’s focus on EUR/USD GBP/USD currency pairs positive correlation. The correlation of these pairs goes above 80 per cent, meaning that an upward or downward trend of one pair goes in parallel with the other. The variations occur only 10 per cent of the time. Sudden deviations are always possible due to many factors, such as political or economic events. In general, these pairs tend to go in the same direction.
GBP/USD and EUR/USD are highly correlated
The strong correlation specifically for GBP/USD and EUR/USD comes from the base or money currency being the same – USD. Every change regarding the strength of the US economy and, consequently, the US currency will reflect on the particular trading currency. For instance, when unemployment rates rise, the US dollar falls, and the EUR/USD currency pair goes up. The same means for the GBP/USD.
Among the other pairs that go in the same direction, the strongest correlation has AUD/USD, NZD/USD, EUR/JPY, AUD/JPY, and NZD/JPY. The patterns and the amplitude of their movements can largely differ.
Strongest negatively correlated currency pairs
Among the pairs that tend to move in diametrically opposite directions are USD/CHF, USD/JPY, USD/CAD, USD/NOK, USD/SEK, USD/DKK, and USD/SGD. Let’s take, for example, the negative correlation between EUR/USD and USD/CHF. The other will trend down when the first pair goes up and vice versa.
The reason behind this strong negative correlation lies in the fact that these pairs have the USD in common. But the opposite will happen compared to the above-explained positive correlation example. In an economic crisis, people search for safe havens, such as the USD.
The US dollar strengthens, pulling EUR/USD currency pairs down and lifting the USD/CHF pair. Furthermore, the euro and the Swiss have grown strong economic relationships and are big trading partners reflecting the currency pair trends.
Once trading major currencies, it’s crucial to understand which currency pairs are correlated and how they move in relation to one another. That’s the number one task of any motivated trader out there! Keep in mind that positive correlations indicate that two currencies tend to move in the same direction, while inverse correlations suggest that they move in opposite directions.
Commodity correlations, generally speaking, also play a significant role in the currency market, as commodity prices can impact the value of currencies tied to those commodities. By understanding these correlations, traders can develop a more nuanced understanding of the market and make more informed decisions.
Therefore, before taking a position, consider which currency pairs are positively or inversely correlated and how commodity prices may impact your trades. With this knowledge, traders can reduce their risks and increase their chances of success in the dynamic world of currency trading.