A successful forex trader knows his financial limits and understands the sensitivity of his portfolio in the market and the fact that currencies are priced in pairs, and no single pair trades completely free of another. Once - as a forex trader you are conscious of these correlations and how they revolutionize, you can use them to manage your overall portfolio's disclosure quite easily.
What is Correlation? The reason why a currency’s independence in pairs is easy to see is because, when a trader compares one currency to another, and brings in a third currency, it becomes evident that the currency must be somewhat correlated to one if not both of the other currency pairs. The trader also needs to realize that the interdependence among currencies comes from much more than the simple fact that they are in pairs, where some currency pairs move in a repetitive cycle, other currency pairs may repel, due to external, complex forces.
In the monetary world, correlation is the numerical measure of the relationship between two securities, the correlation coefficient usually ranges between -1 and +1 Where a correlation of +1 implies that the two currency pairs will move in the same course all of the time and a correlation of -1 implies that the two currency pairs will move in the opposite direction all of the time. And a statistical correlation of zero implies that the relationship linking the currency pairs is entirely unsystematic.
Changing CorrelationsAfter thoroughly studying and understanding currency correlation tables you will realize that correlations do tend to change and thus, the shifts in the correlations are imperative. The world is constantly changing and the correlations that you see right now will be nowhere in sight in the near distant future, thus it would be best for the trader to look at the six-month trailing rather than just contemporary correlations. A six-month trailing will provide the trader with a clearer perspective on the average six-month relationship between the two currency pairs accurately.
Uses of CorrelationsThe most important advantage of correlations is that they can help you avoid entering two positions that cancel each other out at once, which might be the same thing as having virtually no position. A trader can use also different point values for his or her advantage while trading.
Regardless of whether you are looking to branch out your positions or find alternating pairs to influence your outlook, it is very important to be attentive of the correlation between different currency pairs and their irregular trends as this is powerful knowledge for all professional traders holding more than one currency pair in their trading accounts. Currency correlation knowledge can help traders, diversify, hedge or even double up on their profits with ease.
All in all, in order to become a successful trader, it is important to understand how different currency pairs move in relation to each other to and hence understand their exposure. Learning about currency correlation enables traders to manage their portfolios overall more suitably regardless of their trading strategy and whether or not they are looking to diversify their positions.
