The correlation matrix in forex markets

The currency pairs correlation matrix shows the statistical correlation existing between any currency pair selected by a trader, on his chosen timeframe. Correlation is a statistical index which tells how a currency pair follows the same movement of another currency pair and how strong this co-movement is. The currency pairs correlation matrix is an useful tool for forex traders who wish to detect all the possible combinations of trades and their related risks.

Correlation is measured on a scale of +100 to -100, or +1.0% to -1.0%, in a percentage scale. A value of +1.0% (perfectly positive correlation) means that two currency pairs move perfectly identically. A value of -1.0% (perfectly negative correlation) means the opposite. A value of 0.0% (absence of correlation) means that two currency pairs have moved completely independently.

When two currency pairs show a strong positive correlation, this means that we don’t expect a high trading risk. For example, if the GBPUSD and the CADUSD show a strong correlation, say 0.8%, this means that trading both pairs will have the same effects as placing one big single trade, instead of two separate trades. If the correlation is strongly negative, say -0.8%, it is like not to have trade at all. Since the currency pairs move in the opposite directions, the profit obtained on one trade is cancelled out by the loss obtained on the other trade.

In order to plan a profitable strategy, a trader should always focus on pair combinations showing weak correlation, in order to obtain a basket of independent trades.

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