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Some currency pairs often move in one direction. Others - in opposite directions. The relationship of motion of different tools can be used for certain purposes in forex trading. For example, you can use correlation to diversify forex portfolio and risk profile. Correlation is also used to hedge positions.

Correlation of currency pairs shows how one-directional (or in different directions), moving the tools in the past (statistically). The correlation coefficient, a number between -1 and +1, indicates how monetary instruments correlate with each other. For example, if a pair GBP / USD and EUR / USD correlation coefficient is over 0.80, then we say that these pairs are highly correlated: if the GBP / USD goes up, the EUR / USD, most likely will go there too. Therefore, the discovery of additional positions in other correlated pair will increase the risks and have a negative impact on portfolio diversification. On the other hand, the correlation coefficient of pair EUR / USD and USD / CHF, may amount to -0.80, which means that, if the EUR / USD will move up, then the pair USD / CHF, rather, he went down. Therefore, the transaction is to increase by USD / CHF can be used to hedge a long position on EUR / USD. If the correlation coefficient of two pairs of near 0, it is likely they will move independently of each other.

Must also remember that the correlation coefficient of currency pairs may vary over time - due to changes in monetary policy of any changes in the economic and political spheres. For example, agreement on the extensive trade ties between the two countries could lead to the fact that the currencies of these countries in the future will correlate very strongly. Changes in the correlations tend to strongly influence the risk profile of the traders.

Calculation of the correlation coefficient

Correlation coefficient of the two currency pairs is calculated as follows:

Where:

How to interpret the correlation coefficient is

Negative coefficient means that the currency pairs move in opposite directions - almost mirror image, ie if the graph of one pair of facing up, then another currency pair is moving down (or vice versa).

Values below are given with the + sign, the correlation with the minus sign respect to the opposite direction of the pair.

• From 0,0 to 0,2 - a very weak correlation.


• From 0,2 to 0,4 - low correlation (low).


• From 0,4 to 0,7 - moderate correlation.


• From 0,7 to 0,9 - a high correlation.


• From 0,9 to 1,0 - a very strong correlation.