When you know about the existence of such connections and their direction and extent, you can use your knowledge to significantly increase profits and the number of available trading setups. Correlation of currency pairs can become an indispensable tool in market analysis and decision making.
Many traders believe diversifying their trades by trading in different pairs can reduce the risk. But many currency pairs tend to move in the same direction in case of positive correlation. It is the most substantial reason to remember the most correlated Forex pairs list.
More on Correlation
Correlation occurs everywhere in Forex:
- Between currency pairs due to the presence of the same currency in both instruments.
- Between currency and commodities. For example, the relationship of oil to the Canadian and Australian dollars, or gold to the Australian currency.
- Between currencies and indices.
Let's focus on the relation between currency pairs. In simple words, correlation is the synchronicity of the movement of trading instruments. This relation is of several types:
- Direct or positive, when two instruments move as synchronously as possible in the same direction. Higher correlation tells you that pairs’ movements will be most similar. An example would be the EUR/JPY and AUD/JPY currency pairs. If the Japanese yen rate starts to decline, both pairs will move in the same direction.
- Reverse or negative, when the instruments move simultaneously but in opposite directions. This is the case when the same currency is the base and quoted in two different pairs. Take a look at EUR/USD and USD/JPY pairs. The strengthening of the US dollar will force the pairs to move in different directions.
- Zero, when the relation between the instruments is completely random and unpredictable.
Remember that the US dollar has a great influence even on those currency pairs in which it is not represented. A sharp decline or rise of USD can directly or inversely correlate with any instrument.
List of Correlated Forex Pairs in the Same Direction:
- EUR/USD and GBP/USD
- EUR/USD and AUD/USD
- USD/CHF and USD/JPY
- EUR/USD and NZD/USD
- AUD/USD and NZD/USD
List of Correlated Forex Pairs in the Opposite Direction:
- EUR/USD and USD/CHF
- GBP/USD and USD/JPY
- USD/JPY and AUD/USD
- USD/CAD and AUD/USD
- GBP/USD and USD/CHF
Correlation Indicators
You can use indicators to check and measure correlation. You can use numerical indicators or look at the movement ratio visually.
In a visual way, you combine two charts in one field to actually see the current correlation. The numbers will tell you the level of the ratio. The bond ranges from -1 to +1. The closer the indicator is to +1 or -1, the more synchronously currency pairs will move, in the forward (in the first case) or reverse (in the second case) directions.
Remember that the level of correlation between instruments is constantly fluctuating. Use the indicator before making each decision.
There are several great ways of using currency pair correlation in trading. In the next article, we will talk about the strategies that even novice traders can use to increase their chances of making the right trading decision. Don’t miss it!