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The ability to understand influential factors is vital to your success as a currency trader. You need to determine the sensitivity level of particular currencies, as well as the currency pairs, in your portfolio; doing so lets you avoid overexposure, recognize diversification opportunities, and double profitable positions.
Remember, currencies are traded in pairs and a single currency in a pair can be paired with a different currency; they are all interdependent. If the value of one currency pair is affected, it means that the value of the other pair is affected, too. The fact that currencies are dependent on other currencies is advantageous.
Defining Currency Correlation
The subject of currency correlation enlightens you on currency interdependence; there are currency pairs that pursue a similar direction and there are currency pairs that move in opposite paths. For instance, with the Swissie or the currency pair USD (or the US Dollar) and CHF (or the Swiss Franc), it is known to be correlated to the currency pair EUR (or the Euro) and USD. If price movement is observable in EUR/USD, you can expect price movement in the USD/CHF pair.
Correlation Coefficient
With regard to currency correlation, the discussion on the correlation coefficient is addressed; it emphasizes that currency correlation can be either positive or negative. It is implicative of the three typical movements of a particular correlated pair: (1) they can move in a similar direction strictly 100% of the time, (2) they can move in opposite directions strictly 100% of the time, and (3) they can move randomly. When calculated, the figure ranges between +1, 0, and -1.
The Need for Updates
It is important to note that the currency correlation changes over time; in fact, according to a study done by BIS (or the Bank for International Settlements), it can change daily. The alteration is due to the general trader sentiment, as well as various global factors (e.g. monetary policies, commodity prices, political affairs). There may be strong correlations, but it does not mean that the strength of the interdependence will always remain.
For short-term traders, turning to correlation tables frequently (or before a trading session commences) is advised. Although they may be aiming for the generation of minimum profit, knowing the current correlation data can provide them more accurate positions.
And, for long-term traders, it is recommended to review currency correlation tables every six months. This grants a clear perspective of the correlation status of currency pairs regardless of the impact of different economic factors for a six-month period.
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