Understanding Currency Pair Correlations Will Preserve Your Profits

If you have been trading foreign currencies for a while, you realize that there are certain pairs that react to the market just like other pairs.  Understanding which pairs do not act like the other is probably even more important if you are accustomed to trading multiple pairs at the same time.

Many traders who hold trades for days to months should really take a look a the currency correlations that I have pointed out here.

An Example of Pairs that Correlate well:

AUD/USD and NZD/USD

If you were to go long on both the AUD/USD and NZD/USD, you would probably either double your profits or double your losses.  You might as well just buy twice as many lots for one of the pairs.

That being said, it would make absolutely no sense to go long with the AUD/USD and then short with the NZD/USD.  You would completely wipe out your profits and be left with nothing.  Starting to see why some traders only trade one pair?  One less thing to worry about!

The correlation chart below was developed at Mataf.net, and is fully customizable from the website.  The numbers that you see are percentages of the correlation between two pairs from -100% to +100%.  I have circled pairs that are above 80% correlation, or below the 80% threshold.  This means that if the correlation is over 80%, I wouldn’t buy one and sell the other.  And if the correlation is  -80%, there is no point in going in the same direction with these pairs.

What you should look for in this case is holding pairs at the same time that have minimal correlation at all.  Therefore you don’t have to worry that they will go in the opposite direction and wipe out your profits, or go in the same direction and double your losses.  It just makes good sense.  Below, I have circled the pairs that have less than a 20% correlation for daily candles.

Trading these pairs at the same time is safe bet that your wins or losses won’t be amplified.  I hope this helped some of you and will make you look at this before you open multiple pairs.

Posted in Categories: Australia, Contributor, External Research, Forex, New Zealand, USA.

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