Did you know that the forex market has a system in place?
If one currency pair moves, a particular pair either follows suit or moves in a perfect inverse direction.
That’s because of forex currency correlation – a trading concept in which two forex pairs are affected by the prevailing market trend or fundamental events.
Effectively utilizing the currency correlation in your forex trading strategy allows you to explore a new way to profit from the market. This TRU Insight walks you through everything you must know to trade forex correlation pairs to grow your trading capital.
Quick Recap: How Forex Trading Works?
Let us first look at the currency pair, which is your asset to participate in the forex market.
As the name suggests, a currency pair comprises two currency units – the base currency and the quote currency.
Let’s look at the table below to differentiate the role of the two currencies in the pair:
| Currency Pair | Order | Going Long (Buy) | Going Short (Sell) |
| Base Currency | The first currency listed in the pair | Buy the base currency using the quote currency | Sell the base currency for |
| Quote Currency | The last currency listed in the pair | Sell the quote currency for the base currency | Buy the quote currency using the base currency |
To put it simply, the roles of the base and quote currencies are comparable. It solely depends on the position of your trade, whether you’re going long or short.
Now, you must monitor the value of the two currencies in the pair to identify the pair’s future direction and profit from your trade.
This approach is easier said than done. As the forex markets are complex, a currency pair moves in myriad ways. This requires you to look at various market areas, analyze the necessary data, interpret their market implications, and determine the accuracy of their signals.
Again, there’s too much legwork involved in trading.
But did you know that you can exploit the system in place in the forex markets? That’s the currency correlations between two or more currency pairs.
Briefly, currency pair correlations suggest that the two forex pairs move relative to each other – whether in a similar or inverse direction.
A trader’s skill to identify, analyze, and interpret currency correlations is valuable in your trading arsenal as it allows you to potentially profit from two or more pairs by simply analyzing one.
How Trading Forex Correlation Pairs Works?
Again, currency correlation allows you to identify the potential currency pair movement by looking at another pair’s movement.
This concept essentially suggests that there are underlying relationships between the two currency pairs, making them move in a relative direction from one another.
But what happens between the currency pairs to make them move correlatedly?
Simple – both currency pairs were affected by the same fundamental events.
Such influential fundamental events include monetary policy (interest rate cut), economic indicators (GBP, inflation, or unemployment rate), global trade relationships, and overall market sentiments.
But remember that such fundamental events change – their influence in the market is never static. Ultimately, it’s essential to keep in mind that currency correlations should never be treated as constant.
Read More: TradersUnited – Fundamental Analysis and Its Importance to Forex Trading: Ultimate Guide in Trading Forex Correlation PairsMeasuring and Reading Currency Correlation
You must understand the currency correlation coefficient to measure and read currency correlations effectively.
At its core, the correlation coefficient is a statistical measurement that shows the relative strength of the correlation signal.
The correlation coefficient scale ranges from –1.0 to +1.0 0. The correlation coefficient close to the whole number indicates a strong signal.
Here are the three signals provided by the correlation coefficient:
- Negative Correlation (-1.0 to -0.01): The currency pairs move inversely.
- Positive Correlation (1.0 to 0.01): The currency pairs move similarly.
- Neutral Correlation (0): The currency pairs move in a completely random direction.
Now, how do you get the correlation coefficient of the two currency pairs?
You simply get the closing prices of two currency pairs over a specific period and plot them into your spreadsheet software to automate the calculation.
How To Measure Currency Correlation Coefficients on Microsoft Excel
Various online resources show the correlation coefficients of currency pairs. However, getting such trading data yourself can be your edge to make analysis and trading more personalized.
The good thing is you can use online spreadsheet software to automate your correlation coefficient calculation.
For this guide, we’ll use Microsoft Excel. However, you can use Google Sheets or other preferred spreadsheet software.
Follow these seven easy steps to determine the currency correlation coefficients using Microsoft Excel:
Step #1. Get The Historical Price Data of Your Pairs
First, you must get the historical price data of the pairs in your portfolio.
Various online charting platforms allow you to download or export price data for free. Simply google “[currency pair]” historical price data,” and you’ll have access to different charting platforms for that specific forex pair.
Once you’re on a charting platform, adjust the time frame based on your liking. The time frame can be daily, weekly, or monthly. Remember, the bigger the time frame, the better.
Typically, charting platforms give you OCLH price data – the price’s open, close, high, and low.
However, the data you only need to calculate currency correlation is the closing price for each period.
After fine-tuning your preferred data, download it in any Excel-supported format (.xlsx, .xls, or .csv)
Repeat this process for all currency pairs in your portfolio.
Step #2. Import Your Data to Microsoft Excel
After securing your pairs’ historical price data, you can import them into your Microsoft Excel.
Here’s how to import the new Excel workbook into your existing master workbook.
- Open Microsoft Excel
- Create a blank workbook (spreadsheet)
- Rename the workbook
- Go to the “Data” menu
- Select “Get Data”, choose “From File”, and then click on “From Excel Workbook”
- Click on “Load” to insert the data into the worksheet
- Repeat the process for all currency pairs
Remember only to use a single master spreadsheet to avoid confusion. You must only have one truth when handling a large amount of data.
Step #3. Organize Each Pair’s Price Data Side by Side
After importing the pairs’ price data, organize your workbook in this format:
- Columns are currency pairs
- Rows are price periods.
Otherwise, you can’t use the correlation function.
Note: Ideally, all currency pairs should have the same period.
Step #4. Apply =CORREL( Function at a Cell Below Each Column
When you finish organizing your price data, you can get the pairs’ correlation coefficient.
Type in the =CORREL( function at the bottom of your first comparison pair. Microsoft Excel will automatically apply the correlation formula after selecting your preferred range.
Your data range represents your preferred correlation period for a day, week, month, or year.
Step #5. Highlight Your Chosen Range from the First Pair
Once you input the correlation function ‘=CORREL)’, you then select the range you want to analyze.
The variable should include a letter (column) and a range between two numbers (rows).
Again, this range represents the market period in which you want to find the correlation coefficient.
Say you want to find the one-month correlation between the EUR/USD and USD/JPY markets. Then, your range should include 30-day data.
Read more: TradersUnited – Monitor Multiple Time Frames to Trade Forex : Ultimate Guide in Trading Forex Correlation PairsStep #6. Add Comma After the First Range
After selecting the data range for the first currency pair, type in the comma sign (,) to separate the next range from the previous one.
Step #7. Highlight Your Chosen Range from the Comparison Pair
Finally, go to the next column (pair) and select the range similar to your first pair.
Doing this correctly completes your correlation formula. Microsoft Excel will automatically transform the formula into a correlation coefficient.
Currency Correlation Is Important for Risk Exposure Management
Never expose your trading capital to a single risk.
That’s among the golden rules in online trading. And thankfully, there are various risk management techniques to avoid overexposure.
With currency correlation, you can hit two birds with one stone.
To hedge risks or offset your running losses, you can open a position with a forex pair that correlates with your open position.
Assume your EUR/USD long position is currently in a bearish market. Since the GBP/USD is known to be positively correlated with your open position, entering a short position in the declining pound-dollar market will offset your floating losses from your euro-dollar position.
Currency correlation can also magnify your potential profits. How? Let us look back at the example above.
Since the EUR/USD and GBP/USD markets are positively correlated, you can expect them to move in a similar direction. Thus, if your euro-dollar position is winning, placing a similar position on the pound-dollar markets would help you bag two times your supposed profit.
Beware: Currency Correlations Are Different Depending on Time Frames
The correlation coefficient you’ll get varies depending on the timeframe analyzed.
That is why it’s essential to determine how long you’re supposed to hold your position to choose the most suitable coefficient timeframe to trade.
Additionally, the factors driving the correlation between the currencies vary between short-term and long-term trading.
As the market tends to experience short-term fluctuations during news events and releases, these factors are considered the main drivers for short-term currency correlations.
Fundamental economic factors like GBP growth, interest rates, and inflation rates have long-term implications on currency pair movements. This ultimately contributes to the long-term correlation between currency pairs.
