As a forex trader, if you check several different currency pairs to find the
trade setups, you should be aware of the currency pairs correlation, because of
two main reasons:
1- You avoid taking the same position with several correlated currency pairs
at the same time and so you do not multiply your risk. Additionally, you avoid
taking the positions with the currency pairs that move against each other, at
the same time. 2- If you know the currency pairs correlations, it may help you
to predict the direction and movement of a currency pair, through the signals
that you see on the other correlated currency pairs.
Now I explain how currency pairs correlation helps. Lets start with the 4
major currency pairs: EURUSD ; GBPUSD ; USDJPY and USDCHF.
In both of the first two currency pairs (EURUSD and GBPUSD), USD works as
the money. As you know, the first currency in currency pairs is known as the
commodity and the second one is the money. So when you buy EURUSD, it means you
pay USD to buy Euro. In EURUSD and GBPUSD, the currency that works as the money
is the same (USD). The commodity of these pairs are both related to two big
European economies. These two currencies are highly connected and related to
each other and in 99% of the cases they move on the same direction and form the
same buy/sell signals. Just recently, because of the economy crisis, they moved
a little differently but their main bias is still the same.
What does it mean? It means if EURUSD shows a buy signal, GBPUSD should also
show a buy signal with minor differences in the strength and shape of the
signal. If you analyze the market and you come to this conclusion that you
should go short with EURUSD and at the same time you decided to go long with
GBPUSD, it means something is wrong with your analysis and one of your analysis
is wrong. So you should not take any position until you see the same signal in
both of these pairs. Of course, when these pairs really show two different
direction (which rarely happens), it will be a signal to trade EUR-GBP. I will
tell you how.
Accordingly, USD-CHF and USDJPY behave so similar but not as similar as
EURUSD and GBPUSD, because in USD-CHF and USDJPY, money is different. Swiss
Franc and Japanese Yen have some similarities because both of them belong to
oil consumer countries but the volume of industrial trades in Japan, makes JPY
different.
Generally, when you analyze the four major currency pairs, if you see buy
signals in EURUSD and GBPUSD, you should see sell signals in USDJPY. If you
also see a sell signal in USD-CHF, then your analysis is more reliable.
Otherwise, you have to revise and redo your analysis.
EURUSD, GBPUSD, AUDUSD, NZDUSD, GBPJPY, EURJPY, AUDJPY and NZDJPY usually
have the same direction. Just their movement pattern sometimes becomes more
similar to each other and sometimes less.
What do I prefer?
If I find a sell signal with EURUSD and GBPUSD and a buy signal with USDJPY,
I prefer to take the short position with one of the EURUSD or GBPUSD because
downward movements are usually stronger. I will not take the short position
with EURUSD or GBPUSD and the long position with USDJPY at the same time,
because if any of these positions goes against me, the other one will do the
same. So I don’t double my risk by taking two opposite positions with two
currency pairs that move against each other.
How to use the currency pairs correlation to predict the direction of the market?
When I have a signal with a pair, but I need confirmation to take the
position, I refer to the correlated currency pairs or cross currency pairs and
look for the confirmation. For example I see a MACD Divergence in USDCAD four
hours chart but there is no close support breakout in USDCAD four hours or one
hour chart. I want to take a short position but I just need a confirmation. If
I wait for the confirmation, it can become too late and I may miss the chance.
I check a correlated currency pair like USDSGD and if I see a support breakout
in it, I take the short position with USDCAD. Now the question is why I don’t
take the short position with USDSGD and I use its support breakout to go short
with USDCAD? I do it because USDCAD movements are stronger and more profitable.
I use USDSGD just as an indicator to trade USCAD.
It happens that you take a position with a currency pair, but it doesn’t
work properly and you don’t know if it was a good decision or not. On the other
hand, you don’t see any sharp signal on that currency pair to help you decide
if you want to keep the position or close it. In such cases, you can check a
correlated currency pair and look for a continuation or reversal signal. It
helps you to decide about the position you have.
Sometimes, some correlated currency pairs don’t move in the way that they
are supposed to move. For example EURUSD and USDJPY go up at the same time,
whereas they usually move against each other. It can happen when Euro value
goes up and USD value doesn’t have a significant change, but at the same time
JPY value goes down, because of some reason. In these cases, you can use the
below table to find and trade the currency pair that its movement is
intensified by an unusual movement in two other currency pairs. In this
example, if EURUSD and USDJPY go up at the same time, EURJPY will go up much
stronger (see the below chart).
Or if EURUSD goes up and AUDUSD goes down at the same time, EUR-AUD goes up
strongly.
Another important example: If EURUSD goes up and GBPUSD goes down at the
same time, EURGBP goes up strongly. Maybe this is the most important case that
we can trade based on this rule. It happens many times that EURUSD and GBPUSD
move against each other and that is the best time to trade EURGBP. Now you know
why EURGBP doesn’t move strongly most of the time. It is because EURUSD and GBPUSD
move in the same direction most of the time. For example they go up at the same
time and so EURGBP doesn’t show any significant movement because when both of
the currencies of a currency pair go up or down at the same time, that currency
pair doesn’t show any strong movement and direction (I hope you know why a
currency pair goes up or down. It goes up when the first currency value goes up
OR the second currency value goes down. For example EURUSD goes up, if Euro
value goes up or USD value goes down. If this happens at the same time, then
EURUSD goes up much stronger).
The below chart includes almost all of these unusual movements and their
results on the third currency pair.
if EURUSD and USDJPY then EURJPY means if EURUSD and USDJPY go
up at the same time, then EURJPY goes up much stronger.
Sumber: www.fxkeys.com
