Welcome to this Forex Correlation Indicator on our best forex indicator blog. If you are a new trader, you might have come across this situation where whenever a particular currency rises in price, another falls in price. In another case, whenever a specific currency rises, the other currency pair also rises. What gives rise to this situation, and why does a particular currency behave in such a manner? In this article, you will learn about currency correlation because it is an essential aspect of risk management. Without further ado, let us begin.
What is Currency Correlation?
Correlation, in its literal definition, means the relationship that exists between two or more things in such a way that they are mutually or complementarily connected. However, in the forex world, currency correlation shows if two currency pairs move in the opposite or same direction within a particular time.
Most professional traders know the importance of currency correlation because no particular currency pair is isolated from the other. This can only be false if you focus on a currency pair during your trading. Otherwise, it is crucial to understand the correlation between different currency pairs.
A trader without a basic understanding of currency correlation and its connection to risk management is willingly exposing his or her account. The truth is you get killed trading multiple pairs simultaneously without knowing what to do. In the forex industry, killing your account is akin to losing your account.
Currency Correlation in Forex Trading
Most beginners tend to look for a forex correlation indicator to get a concept of currency correlation. With currency correlation, traders can diversify the currency pair they trade. This concept is a strategy used by most traders to protect their accounts.
The forex currency correlation is represented through a numerical scale with the coefficient ranging between +1 and -1. This shows the extent of the relationship between such a currency pair. For instance, -1 indicates that the currency pairs will consistently move in the opposite direction; +1 signifies the pair will move in the same direction, whereas when the currency correlation is 0, it means there is no correlation, and the pair is moving randomly.
Examples of Currency correction in the same direction include EUR/USD and AUD/USD, EUR/USD and NZD/USD, USDCHF and USD/JPY, AUD/USD and NZD/USD, AUD/CAD and AUD/CHF. Currencies such as EUR/USD and USD/CHF, GBP/USD and USD/JPY, USD/CAD and AUD/USD, USD/JPY and AUD/USD, and GBP/USD and USD/CHF move in the opposite direction.
Is there anything as a forex correlation indicator?
Yes, there is an instrument such as a forex correlation indicator, which you can find online. An indicator like that takes a statistical analysis of currency pairs moving in the same or opposite directions. Furthermore, it displays the degrees to which currency pairs have moved in an opposite or similar direction.
While we don’t advertise any forex correlation indicator, these indicators help traders to visually pinpoint the average moves that exist between currency pairs using the Meta Trader 4 (MT4).
For many traders, the benefit of using a forex correlation indicatoris that the trader does not require to flick through two different currency pairs they are analyzing to see what is happening on each particular pair. Most forex correlation indicator for MT4 is usually reliable and effective in identifying price divergence between two specific currency pairs, which ordinarily should move in the same direction. However, because of a particular situation, they move in the opposite direction.
The divergence in price movement between the currency pairs suddenly creates a moneymaking opportunity for the trader where they can decide to buy a particular currency pair while selling the other.
Why use Currency Correlation
Professional traders take advantage of currency correlation for hedging a position, inter-market trading, and risk diversification. Most of these traders don’t depend on forex correlation indicators because they have mastered the art of trading. However, for beginners, it is advisable to learn the basics of currency correlation rather than depending on any forex correlation indicator available online.
Hedging a position
Traders use hedging to trade forex correlation. Hedging in forex is usually a strategy where you protect a particular currency pair position from an adverse direction. For instance, if you want to go long on the AUD and decide to buy the AUD/USD pair, then the best hedging strategy is to buy the USD/CHF to hedge off the USD exposure.
Not all forex correlation indicators can identify closely correlated currency pairs in the market. However, if you can do this, it gives you the advantage because specific patterns that are unclear in a particular market become more explicit in the other market.
For instance, there is a correlation between oil and USD/CAD. The reason behind this is that Canada is the largest exporter of crude oil to the United States. This makes the currency pair very sensitive to the commodity price. What this means is that if the price of oil drops, the CAD will weaken against the USD. Another correlation is the AUD and gold – when the price of gold rises, the AUD tends to be strong because Australia is among the foremost producers of gold in the world.
Another essential way to use currency correlation is to diversify your risk. For instance, if you placed three trades (EUR/JPY, USD/JPY, and GBP/NZD), you can analyze each market to ensure there isn’t any correlation.
Conclusion Forex Correlation Indicator
If you want to be a productive and profitable trader, then you must understand currency correlation in forex. You must understand the correlation in one currency pair concerning the other in terms of their opposite direction. With the knowledge of currency correlation, you can effectively manage your capital appropriately.
Notwithstanding your current trading strategy, it is imperative to implement currency correlation into it. If you decide to use a forex correlation indicator, ensure to backtest its accuracy. Remember, you stand to lose your capital because trading forex or any financial instrument comes with risk. It is crucial to ascertain the amount of risk you can accommodate before considering trading in the forex market.