Forex correlation can be a very powerful tool to implement within your trading strategy once you fully understand how it works. I think it is often overlooked by many traders as they feel that it might be too compacted. However, once you have a clear understanding of negative and positive correlation between forex currency pairs, you can use it to help decide if you will be looking to buy or sell a currency pair. I will explain what forex correlation is, how it works and how it can be used to form a simple trading strategy.
What are correlated forex pairs?
A currency correlation in forex is a positive or negative relationship between two separate currency pairs. A currency pair is the quotation of two different currencies, with the value of one currency being quoted against the other. The first listed currency of a currency pair is called the base currency, and the second currency is called the quote currency.
A positive forex correlation means two forex pairs that move together, and a negative forex correlation means that they move in opposite directions. If one currency pair is moving up, the correlated currency pairs should also be moving up. On the other hand, if one currency pair is moving down, the correlated currency pairs should also be moving down.
You can see in the EUR/USD and GBP/USD 1-hour charts below that they are moving in a very similar direction. One could argue that if you are trading long on both pairs, it would be similar to having one larger position on either of them.
What are the most correlated forex pairs?
The currencies below are some of them most correlated forex pairs. They will tend to move in a similar direction which can be used as confirmation before you take a trade. You can even take trades on both currency pairs if they have valid setups, just keep in mind that this is similar to opening a larger position size on just one currency pair.
- AUD/USD vs NZD/USD
- EUR/USD vs GBP/USD
- EUR/USD vs USD/CHF
- GBP/USD vs USD/CAD
- GBP/USD vs USD/CHF
What are non-correlated forex pairs?
This is the opposite to the correlated currency pairs that we discussed above. In this instance, the currency pairs will more often than not move in a different direction. Therefore, if currency pairs are said to have negative correlation, it means that whilst one pair is moving, the other pair is likely to be moving down and vice versa.
Which forex pairs have no correlation?
The currency pairs below are some of those which have no correlation together and will generally tend to move in opposite directions. You can check compare currency pairs before taking a buy or sell signal to see if they both have opposite signals for extra confirmation on your trades. As with correlated currencies, you can take trades on both currency pairs if there are valid signals. However, this might just lead to almost duplicate trades
- EUR/USD vs USD/CHF
- GBP/USD vs USD/JPY
- USD/CAD vs AUD/USD
- USD/JPY vs AUD/USD
- GBP/USD vs USD/CHF
How to trade correlated currency pairs?
Once you know the most correlated forex pairs and non-correlated currency pairs, you can use this information to your advantage. For example, if you found a potential buy signal on the EUR/USD currency pair, you could a correlated currency pair such as the GBP/USD to see if there is a similar buy signal. You could also check a non-correlated pair such as the USD/CHF to see if that was showing a signal for a sell trade for extra confirmation.
Generally speaking, the more confirmation you have from correlated pairs that agree with the trade direction and non-correlated currencies that are going in the opposite direction, the stronger the signal may be. Of course, this is not always the case, so it is important to use a combination of technical indicators, fundamental analysis and price action analysis, to confirm trades.
I think it is sensible to only trade one correlated currency pair at any time. This is because you may end up taking a very similar position otherwise and thus double your risk inadvertently. I would prefer to master one correlated currency pair as they are all likely to have similar signals in any case. Plus, it means less chart analysis and more chance of understanding the ins and outs of how a particular currency pair works.
Correlated forex pairs buy signal
- MACD crosses above main line on both currency pairs
- Price bounces from support level
- Bullish price action
You can see from the EUR/USD and GBP/USD 1-hour charts below that the MACD crossover on both were signalling a buy trade as was the MACD divergence. Price had bounced from recent support and there are bullish candlestick patterns confirming the trade including inside bars. Both of these trades could have made around 400 pips. The stop loss could have been around 25 pips just below recent support.
Correlated forex pairs sell signal
- MACD crosses below main line on both currency pairs
- Price bounces from resistance level
- Bearish price action
On the EUR/USD and GBP/USD charts below, you will see that the sell conditions were met. The MACD crosses over to the downside and the price is moving away from recent resistance. There are bearish candlestick patterns including shooting stars. These trades could have made around 350-450 pips with relatively tight stop losses of 20 pips.
Advantages of forex correlation
- Confirmation of signals
- Discover other opportunities
- Filter out false signals
Disadvantages of forex correlation
- Does not always work
- Need to time your entry/exit
- Some pairs more volatile than others
What is the correlation coefficient?
A correlation coefficient is a statistical measure of the degree to which changes to the value of one variable predict change to the value of another. In positively correlated variables, the value increases or decreases in tandem. In negatively correlated variables, the value of one can increase as the value of the other decreases.
The correlation coefficient is used in pairs trading, and it measures the correlation between different assets – in this case, currency pairs. It ranges from 1 to -1, with 1 representing a perfect positive correlation and -1 representing a perfect negative correlation. If the coefficient value is 0, it means that there is no correlation between the price movements of different currency pairs.
The Pearson correlation coefficient (PCC) is the most used measure of currency correlations in the financial market. Pearson’s correlation coefficient is the test statistics that measures the statistical relationship, or association, between two continuous variables. It is known as the best method of measuring the association between variables of interest because it is based on the method of covariance.
Conclusion: is forex correlation important?
Yes, I think understanding and implementing the correlation between forex currency pairs is a vital part of any trading strategy. We use many different indicators and other forms of market analysis to confirm our trades, so why should we not study forex correlation before making any decisions as well. It is easy to do once you know what to look for and only takes a few minutes at most. That being said, forex correlation simply gives you an indication of what direction a currency pair may be moving. You will need to decide when to enter and exit your trades.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.