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How can you identify correlating pairs and what does it mean?
Posted On 07 Jan 2015
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What correlating means is that when one pair does something the other does the same, so basically they mirror each other either inversely or as an exact correlation. There are a few pairs that do this but it is more particular currencies that tend to correlate or inversely correlate.
One of the most common examples would be the EUR/CHF, these pairs are very close geographically and they are very interlinked economically. Due to the Eurozone being Switzerland main source of business, it is its primary trade partner etc, if the EUR goes up very often the CHF will to and vice versa.
It is very important to understand that there is no set rule, nothing states that any correlation has to last forever, any currencies that are currently correlating could uncorrelate at any time. When it comes to trading it would be unsafe to place trades purely on correlation it would make a lot more sense to look at the fundamentals to see what is driving those currencies. Just because one currency has gone doesn’t always mean that the other should follow. In my opinion if you focus on correlation too much I feel you will struggle to succeed with that tactic.
Another example is correlation across pairs, this happens when one currency is particularly strong, an example of this would be; if everyone was buying the GBP in huge quantities, you would see the GBP pairs all rally, it doesn’t mean the rally’s are going to last.
This will depend on the pairs themselves because one half of the pair may be a strong currency and you would see that plummet back down on the same token it could be paired with a weak currency and would keep rocketing up.
This just outlines again that it is difficult to trade purely on a correlation. So again my advice would be to not base a strategy solely around the correlation of different currencies.
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