Currency correlation tables show the correlation coefficient between currency pairs and a variety of these are available on the internet. The best ones provide data on a wide range of time frames.
In developing a reliable strategy, traders must look for data that has predictive value. A straightforward yet powerful source of predictive data can be found in the price relationship between various currency pairs and commodities over time. Some frequently move closely in tandem while others tend to sharply diverge. Insights into these relationships can form the basis of a strategy and also be used for effectively managing your risk exposure.
Correlation in Forex
Correlation in Forex is a statistical measure showing how much currency pairs tend to move in line with each other or in opposite directions. A number called the correlation coefficient gauges the degree to which currency pairs are correlated in decimal form ranging from -1 to +1.
Positive values indicate that the two currency pairs move in the same direction, negative values show that the pairs move in opposite directions and a value of 0 reflects a totally random relationship.
Here are some guidelines for reading positive correlations:
0.0 to +0.2: Very weak positive correlation
+0.2 to +0.4: Weak positive correlation
+0.4 to +0.7: Moderate positive correlation
+0.7 to +0.9: Strong positive correlation
+0.9 to +1.0: Very strong positive correlation
The inverse applies for negative correlations:
0.0 to -0.2: Very weak negative correlation
-0.2 to -0.4: Weak negative correlation
-0.4 to -0.7: Moderate negative correlation
-0.7 to -0.9: Strong negative correlation
-0.9 to -1.0: Very strong negative correlation
Highly Correlated Currency Pairs
Here is an example of currency pairs with a high positive correlation at the time of this writing: EUR/USD and GBP/CAD (with a current correlation coefficient of +0.95 over 1 month).
Looking at the overlay chart below we can see that prices traded very closely in line over the prior month.
Next, let’s take a look at an example of currency pairs with a strong negative correlation currently: GBP/USD and EUR/GBP (correlation coefficient -0.98 over 1 month).
In the chart below, we can see the almost perfect inverse price relationship between the currency pairs over that period.
Correlations between Currencies and Commodities
A number of interesting correlations exist between currencies and commodities. The Canadian dollar and crude oil have a strong positive correlation, due to the fact that Canada is one of the world’s leading oil producers.
The Australian dollar and gold have a positive correlation, because Australia is a top gold producer, second only to China in 2019.
Gold and the Japanese Yen are also positively correlated, largely because they are very important financial safe-havens. Gold also has a positive correlation with another financial refuge, the Swiss Franc.
Correlation Trading Strategies
A popular way of using correlations in trading is to watch two highly correlated currency pairs and look for one to serve as a leading indicator. In other words, when watching two highly correlated pairs and one makes a move, you might anticipate a move in the other (in the same direction if they are positively correlated and in the opposite direction if they are negatively correlated). This approach can be more effective when combined with an understanding of technical analysis. For example, if one pair breaks through an important technical price level, this can suggest higher odds that the closely correlated pair will react.
Strictly speaking, arbitrage refers to the simultaneous purchase and sale of a similar or identical financial asset in order to capitalize on an imbalance in price. For example, buying the stock of a company on one exchange and selling the same company on a different exchange when prices diverge.
A similar strategy can be used in the Forex market using correlations. When two currencies are historically highly correlated, a trader can try to capitalize on a reversion to the mean by simultaneously buying one pair and selling the other.
Currency Correlations Fluctuate
Currency correlations can and do change over time. Many different fundamental factors can alter the relationships between currency pairs. These can range from shifts in a country’s political stability and economic performance to changing monetary policies and interest rates. As the famous investment disclaimer states; past performance is no guarantee of future results.
Using Currency Correlations to Manage Risk
Understanding correlations can help you to diversify your exposure to market risk. For example, if you are bearish on the British Pound, instead of just selling GBP/USD, you could diversify your exposure by also selling the positively correlated GBP/JPY. You can also hedge an existing position you would like to hold by taking a position in a negatively correlated currency pair.
The Bottom Line
Part of the appeal of using correlations in a trading strategy is that the data is straightforward and easy to interpret. In other strategies, such as using chart patterns for example, there is often a higher degree of complexity and subjectivity. Currency correlations can be effective in developing high probability trading strategies and in managing risk. However, traders must be constantly mindful to changes in the market and understand that correlations are not set in stone, they can easily break down or even reverse.