Currencies and Correlation
Forex trading is among the fields that are fast rising with many newbies joining the market each day. To get started, you need to know currency pairs and currencies correlation and how to use this information to your benefit.
Forex trading involves buying and selling. You use one currency to buy the other and later sell the currency. The process continues. It is like paying money for a commodity and later selling the commodity to get a benefit. To do this, currency pairs have been created. Currency pairs are basically two currencies where one buys the other. For instance EUR-USD is a pair between the Euro and the US dollar. In this case, the first currency is the commodity and the second is the money. Euro is the commodity bought by the US dollar. However, it happens that any forex trade has to be done through USD as it is considered as the universal currency. The process is however automatic and the trader will only need to click the buy or the sell button.
The forex market has four major currency pairs that keeps the field vibrant; these are USD-CHF, GBP-USD, USD-JPY and EUR-USD. The EUR-USD pair is the most popular among the four major pairs in the forex market; it is recorded that 70% of the transactions involve the EUR-USD pair. This however does not mean that 70% of the forex traders specialize on the EUR-USD pair. GBP-JPY is highly active and is considered the most volatile pair among all others.
During forex trading a currency pair may rise while another currency pair falls at the same time. In other instances, a currency pair may fall and another one falls at the same time. Simply put, currency correlation is the statistical analysis of how currency pairs relate to each other. They show whether two currency pairs move in the opposite direction (rise and fall), same direction (either fall or rise) or they move in random direction.
Currency correlation is shown by use of a correlation coefficient. The coefficient ranges from -1 to +1. The correlation may be -1 which means that the two pairs move in opposite direction perfectly or may be +1 which means that the two currency pairs move in the same direction. A correlation coefficient of 0 means that the two currency pairs are independent of each other and move randomly.
How do you use Currency Correlation in your Trading?
- Stay void of counterproductive trade
- By the use of currency correlation, the trader is able to stay out of currency pairs that will cancel each other out and reduce the profit.
- Increase profits
- By looking at the statistics you are able to know which currency pairs have risen and are productive to trade in and which ones to avoid.
- Spreading the risk
- Having the necessary information on currency correlation allows you to trade in more than one currency pair to ensure that you spread your risks as well as the chances to get great profit.
- Avoid fake-outs and detect the breakouts
By use of currency correlation, you are able to see your entry as well as your exit signs. This gives you a chance to plan for the next move to avert any bad signs. Currency correlations change and thus the trader should keep reading the correlation tables to ensure that they trade on the right and productive currency pairs. Currency correlation tables are given in periods from 1 week to 1 year. The closer the coefficient is to zero, the less the relationship between the currency pairs.