When it comes to Forex trading profession, the first thing that comes to our mind is a currency pair. Currency pairs are the combination of two different currencies where the price value changes relatively with another currency. For example, in the EUR/USD currency pair, the value of the Euro may change in contrast with Dollar due to various stimulus.
Smart UK traders always trade in the Forex market by buying a currency pair and selling that currency pair back in the market when the condition is favourable. Now many of you must have noticed that if a certain currency pair rises, another currency pair falls. Again, there might be situations when the fall of a currency pair leads to the downward movement of another currency pair.
If you have ever witnessed any of these cases, then we can say that you have successfully observed currency correlation. The currency correlation is an important event to witness in this market. This is one of the many market indicators which helps you to identify what the market may look like or what impact this correlation would have. In case you never saw such currency correlation, then it is time for you to gear up your game rather than wasting time on other less important things.
What is currency correlation?
By correlation, we mean the dependency of two different things on one another. Similarly, in the currency market, currency correlation means the relationship between two currency pairs based on their price movements. To find more info about the major and minor currency pair, you can access the learn centre at Saxo.
Two currency pairs can move in the same, opposite or random directions at the same time. It is needed to observe how much the influence of one currency is on another pair. If the direction of the two pairs is the same then in case one pair falls, the other pair would also fall. On the other hand, if the direction of the two pairs are contradictory and moves in the opposite direction then if the value of one pair falls, the value of the other pair rises.
When the two pairs are minding their own business and have issues with each other and whatsoever, then the movement of a pair doesn’t influence the other. So, even if the value of one pair falls or rises, it will have no impact on the other.
Why is the correlation important?
Currency correlation can be used as a speculation tool to know which trade would be the most profitable for you. Since there are hundreds of currency pairs in this market, some of them fall while some of them rise at the same time. And, if you have a thorough research about the currency pairs and economic condition, then looking at the charts you can identify which pairs are going to rise or fall in the future. For example, according to the numbers you observed that the EUR/USD pair is falling. Then, the high pairs -correlated with the previously mentioned pair like USD/CAD may also tend to fall.
In this way, you can tell what the movement of a currency pair would like by analysing the movement of another pair. Now, when you analysed that the USD/CAD pair might move down, you could refrain from investing money in that trade to prevent facing loss.
The correlation coefficient
The correlation coefficient is ranged from -1 to +1 and it is mainly of two types. The first one is the perfect positive correlation where currency pairs have a correlation coefficient of +1 to denote that both the pairs will move in the same direction all the time in case a pair changes its movement.
The second type of currency coefficient we have is the perfect negative correlation and here, the currency pairs will have a correlation coefficient of -1 and move in the opposite direction all the time.
In case, the coefficient is 0, it means that both the pairs have no relation with each other and one’s movement doesn’t influence the other. In this way, you can use the currency correlations to be a smarter trader.