CORRELATION COEFFICIENTS on FOREX

14 дек. 2021 г.

Hello everybody!
Professionals have been aware of correlation for a long time and use it profitably. The essence of correlation is not difficult to understand and using it in trading can significantly increase your profit.

Correlation coefficient of currency pairs – what is it?
Correlation is a statistical relationship between two or more random variables.
The correlation coefficient is an index of the interdependence of quotations of different currency pairs.

Correlation of currency pairs is divided into two types: direct (positive) and inverse (mirror or negative).
A positive correlation is a similar movement of quotations of different currency pairs.
Inverse correlation is the reverse movement of the exchange rate of different currency pairs.

For example, EUR/USD and USD/CHF are in a mirror correlation because both European currencies are against the dollar. Any change in the euro affects the franc exchange rate and vice versa, on the chart, the price of the euro and the pound moves the other way around because in the EUR/USD pair, the dollar is in second place, and in USD/CHF in the first.
Method
Analysts have come up with a method that makes it easier to understand the correlation, it is called the correlation coefficient. Using it, you can understand in which range each pair is relative to the other, where +1 is a complete correlation, and -1 is the opposite. The stronger the link between the economies, the stronger the value tends to unity.

Let's consider the main ranges of coefficient values and their impact on the currency pair:
• 1 - Denotes the same movement of currency pairs.
* From 0.9 to 0.5 – High dependence of currency pairs among themselves.
* From 0.5 to 0.1 – There is a decrease in correlation.
* 0 – There is no correlation, the instruments do not depend on each other.
* From 0.1 to -0.5 - Characterized by a decrease in correlation.
* From 0.5 to -0.9 – An increase in correlation and a change in the direction of movement of currency pairs in the opposite direction.
* -1 – Inverse dependence of currency pairs. One price is going down, the other is going up.

Trading options
Novice traders often think that they reduce risks when they invest in different currency pairs, but at the same time they do not understand that a large number of pairs correlate with each other. Forgetting about the correlation, you can start getting double losses.

Correlations can be used to confirm signals.
For example, the analysis of the EUR/USD chart showed growth. To make sure that the forecast is correct, you need to get a reverse confirmation for USD/CHF.
Sometimes, to confirm trading signals, a comparison of three assets that are minimally related to each other is used. Take for example EUR/USD, USD/JPY and EUR/JPY.
• If EUR/USD is predicted to go up, then the forecast for the reverse currency pair USD/JPY should signal a fall. In the event that there is no signal for USD/JPY, then it is necessary to carefully study the behavior of EUR/JPY.

No matter what tactics a trader uses, you always need to remember about correlation and use several pairs with positive and negative correlation in the analysis to increase the accuracy of the forecast.
In addition, correlation helps to hedge transactions. Having decided to invest in one currency pair, you can divide the investment amount into two parts and invest the second part in a currency pair with
Time interval in correlation analysis
The correlation has the ability to change depending on time. It may be that the daily correlation = 0.6, but when switching to a monthly interval, this value increases and shows a strong correlation.
There may be an inverse situation, when the correlation drops relative to the selected interval. Pay attention to this when analyzing.

Traders, if you liked this idea or if you have your own opinion about it, write in the comments. I will be glad 👩💻