The benefits of trading using currency correlations

Posted by jenni on June 6th, 2017

Correlations can also benefit forex traders by allowing them to spread their risk over highly correlated currency pairs. Rather than entering a position on just one currency pair, a portfolio can be diversified between highly correlated pairs in order to lower the risk associated with over-exposure. This is most effective when currency pairs are highly, but not perfectly, correlated. An example may be a long position on both the EUR/USD and AUD/USD which have a generally high correlation. The trade here would assume a devaluing of the USD but by spreading the risk between the two pairs. The difference in monetary policies between the Australian and European Central Banks would also help protect the trade against the rise of the US dollar as they are unlikely to be affected equally and one may therefore absorb some of the negative impact of the rise.

Furthermore, those pairs with a strong negative correlation can be used to hedge against one another. Due to the fact that the number of points movement for the two currencies are unlikely to be equal, traders can take advantage of this by taking opposing positions in order to offset any losses should the trade fail to be profitable. Although this will result in lower profits, the use of negatively correlated pairs to insure losses are limited is a good example of the benefit of understanding currency correlations.

Using currency correlations in trading

Forex markets are intricately-woven reflections of the supply and demand for currencies around the world. Whilst currencies are always quoted in pairs, as an explanation of the relative value of one against the other, they are all interlinked in varying degrees to all other pair’s movements and value. The relationship between these currency pairs is known as their ‘correlation’, or the degree to which the movements of one pair affects the movements of another. Correlations can change over time, with some pairs becoming more or less correlated with one another; however, many currency pairs have a consistent correlation which is important for forex traders who can use these to manage the exposure of their trades and in order to hedge their positions.

Influential factors

Factors which influence the relationship between currency pairs can include geopolitical changes, commodity price fluctuations and, importantly, convergence and divergence of monetary policy. As interest rates and speculation surrounding these is a major driver of currency movements, these can potentially influence the correlation between pairs with similar or opposing interest rate forecasts. Buy Forex Online: With Axis Forex online send money in 100+ currencies to any bank account in the world. Buy forex card and go cashless across the globe.

Source : https://easyforextrading.co/how-to-trade/inflation/