Like synchronized swimmers, some currency pairs move in tandem with each other.
And like magnets of the same poles that touch, other currency pairs move in opposite directions.
When you are simultaneously trading multiple currency pairs in your trading account, the most important thing is to make sure you’re aware of your risk exposure.
You might believe that you’re spreading or diversifying your risk by trading in different pairs, but you should know that many of them tend to move in the same direction.
By trading pairs that are highly correlated, you are just magnifying your risk!
Correlations between pairs can be strong or weak and last for weeks, months, or even years. But always know that they can change on dime.
Staying up-to-date with currency correlations can help you make better decisions if you want to leverage, hedge or diversify your trades.
A few more points to remember
- Coefficients are calculated using daily closing prices.
- Positive coefficients indicate that the two currency pairs are positively correlated, meaning they generally move in the same direction.
- Negative coefficients indicate that the two currency pairs are negatively correlated, meaning they generally move in the opposite directions.
- Correlation coefficient values near or at +1 or -1 mean the two currency pairs are highly related.
- Correlations can be used to hedge, diversity, leverage up positions, and keep you out of positions that might cancel each other out.
Examples of same direction moving currency pairs
- EUR/USD and GBP/USD
- EUR/USD and AUD/USD
- EUR/USD and NZD/USD
- USD/CHF and USD/JPY
- AUD/USD and NZD/USD
Typical inversely moving pairs
- EUR/USD and USD/CHF
- GBP/USD and USD/JPY
- USD/CAD and AUD/USD
- USD/JPY and AUD/USD
- GBP/USD and USD/CHF
When you find yourself wanting to trade two pairs that are highly correlated, its okay if you take both setups. Just make sure you have rules in place when you traded correlated pairs and always stick to your risk management rules!