Specialize In Trading USD (Part II)
Knowing currency correlations between the major pairs can help you a lot in your trading. Suppose you have the data about the currency correlations of the major currency pairs. The correlation between GBP/USD and EUR/USD is 0.68. This correlation coefficient is positive and it means both the pairs move in the same direction 68% of the time.
USD/CHF and EUR/USD have a correlation coefficient of -0.975 and is pretty close to minus one. The negative correlation coefficient means both USD/CHF and EUR/USD pairs move in the opposite direction almost 97.5% of the time. In other words, if USD/CHF moves up, the pair EUR/USD will move down!
You have this information about the recent correlation coefficients. It tells you how much these pairs move in the same direction or opposite direction. Suppose you trade both the currency pairs USD/CHF and EUR/USD by going long. What you will be doing by going long on both the positively correlated pairs is in fact canceling both the long positions.
If you win on USD/CHF pair, you will lose on EUR/USD pair. Due to the negative correlation between the two pairs, the two trades would effectively cancel each other. A savvy investor would go long on USD/CHF. At the same time he/she will go short on EUR/USD. So he/she will be shorting USD in both the trades and diversifying the USD bearish investment.
Currency correlations can help you in making entry and exit decisions for each trade. Lets suppose GBP/USD starts showing volatility. The pair approaches a resistance level. You plan on going long if there is a breakout.
However, you notice on the charts that the other three pairs are not moving as much as the GBP/USD. EUR/USD is not moving up on the chart. USD/CHF is not moving down on the chart. USD/JPY is not moving down on the chart. This means that the move in GBP/USD is solely pound driven. The move maybe related to some news in the British economy.
You know now that the move in GBP/USD pair is GBP driven. The move is not US Dollar driven. You have isolated the cause of movement in GBP/USD pair and can take advantage of this information. Ignore the GBP driven move. Dont enter into any trade. Wait for a later opportunity. An opportunity that involves simultaneous correlated moves of all the major pairs!
Take another example. Suppose you have entered a short EUR/USD trade. You want to know whether the pair will either proceed down towards your profit target or go against you and cause you to exit the trade with a small loss.
Your EUR/USD has broken the S1 support pivot level. It is heading towards M1. Take a look at the pair EUR/GBP. You find that it has paused at its S1 support pivot level and is showing signs of reversing to the upside.
In this type of a situation, knowledge of currency correlations can tell you if EUR/GBP breaks through the S1 level, you are poised for a profitable trade. However, if it reverses and heads back to the upside, you should watch the indicators and exit before taking a big loss. As you mature in forex trading, you might consider trading a basket of all the major currencies. - 23217
USD/CHF and EUR/USD have a correlation coefficient of -0.975 and is pretty close to minus one. The negative correlation coefficient means both USD/CHF and EUR/USD pairs move in the opposite direction almost 97.5% of the time. In other words, if USD/CHF moves up, the pair EUR/USD will move down!
You have this information about the recent correlation coefficients. It tells you how much these pairs move in the same direction or opposite direction. Suppose you trade both the currency pairs USD/CHF and EUR/USD by going long. What you will be doing by going long on both the positively correlated pairs is in fact canceling both the long positions.
If you win on USD/CHF pair, you will lose on EUR/USD pair. Due to the negative correlation between the two pairs, the two trades would effectively cancel each other. A savvy investor would go long on USD/CHF. At the same time he/she will go short on EUR/USD. So he/she will be shorting USD in both the trades and diversifying the USD bearish investment.
Currency correlations can help you in making entry and exit decisions for each trade. Lets suppose GBP/USD starts showing volatility. The pair approaches a resistance level. You plan on going long if there is a breakout.
However, you notice on the charts that the other three pairs are not moving as much as the GBP/USD. EUR/USD is not moving up on the chart. USD/CHF is not moving down on the chart. USD/JPY is not moving down on the chart. This means that the move in GBP/USD is solely pound driven. The move maybe related to some news in the British economy.
You know now that the move in GBP/USD pair is GBP driven. The move is not US Dollar driven. You have isolated the cause of movement in GBP/USD pair and can take advantage of this information. Ignore the GBP driven move. Dont enter into any trade. Wait for a later opportunity. An opportunity that involves simultaneous correlated moves of all the major pairs!
Take another example. Suppose you have entered a short EUR/USD trade. You want to know whether the pair will either proceed down towards your profit target or go against you and cause you to exit the trade with a small loss.
Your EUR/USD has broken the S1 support pivot level. It is heading towards M1. Take a look at the pair EUR/GBP. You find that it has paused at its S1 support pivot level and is showing signs of reversing to the upside.
In this type of a situation, knowledge of currency correlations can tell you if EUR/GBP breaks through the S1 level, you are poised for a profitable trade. However, if it reverses and heads back to the upside, you should watch the indicators and exit before taking a big loss. As you mature in forex trading, you might consider trading a basket of all the major currencies. - 23217
About the Author:
Mr. Ahmad Hassam is a Harvard University Graduate. He is interested in day trading stocks and currencies. Know These Forex Broker Games. Learn Forex Trading!
posted by X - Men @ 2:23 AM
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