The correlation is the capacity that have some pairs of currencies in the Forex market among themselves so that their price moves in the same direction (positive correlation) or in the opposite direction (negative correlation) most of the time.
Why should you learn about such correlations?
If you want to be a profitable trader in the Forex market, you must be aware of the correlation between the major currency pairs because that can help you in 2 key areas:
1 - to learn correlations between currency pairs, can best make your trading decisions:
On many occasions, you can predict successfully the direction of the price of a currency pair via signals of buying or selling seen in other correlated pairs.
It can also make you think before opening a position if you detect a signal to buy and at the same time one of sale in other positively correlated pair or the same signal buy or sell in pairs correlated negatively. The position you are thinking of opening may not be adequate.
2. know this correlation also will prevent you to increase your level of risk:
If you open two positions in the same sense in pairs correlated positively you are doubling the risk since it is relatively easy to go in the same direction. If you have matched and they are moving in your favor will get benefit on both but if you make mistakes the two will cause you loss. The same applies to opening two inverse positions into pairs correlated negatively.
How can you use the correlation of currency pairs to predict the direction of the price?
-When you detect a signal of purchase or sale in a given pair, before opening a position you can analyze other pairs correlated positively to confirm which give a similar signal and also other pairs negatively correlated to see if they give the opposite signal.
-When you have an open position and do not see clear signals to maintain it for longer or close it, you can help these positive and negative correlations with other peers to look for signals of continuation or change of trend.
-Historically, for a long time when two pairs have a correlation positive strong and you detect between the two different signals, it is relatively easy to price both again soon go in the same direction. If you correctly identify what is the pair that is moving more slowly you can make a choice for opening a position and try to get benefits when you retrieve the address of the other pair.
-There are traders who use the correlation as hedging (hedging) strategy by opening leading position in a pair and another secondary smaller in the same sense in another pair with negative correlation. If the leading position moves in our favor the benefits they will be greater than the loss of the secondary position and if you go against us, losses will be greater than the benefits but will reduce considerably. If you are a beginner it is better that you focus on detect strong signals and that values the suitability of this type of coverage when you have more experience.
- There are many traders that if they find a signal to sell strong in the EUR/USD and GBP/USD, confirmed by a signal to buy USD/JPY and USD/CHF, prefer to open the position of sale in EUR/USD or GBP/USD (instead of a purchase in USD/JPY or USD/CHF) because usually movements to the low they tend to be stronger (because of fear) and allow to obtain greater benefits in a shortest time.