Introduction We've talked about correlations in Mod 7. Managing Risk  mainly around stock markets. Here we'll talk about Forex. Currency pairs can either have a positive, counter or random relationship with other currency pairs and these relationships can come and go over time, depending on economic and market conditions. Understanding these relationships, which can be viewed in correlation tables allows traders to:
To measure these currency pair correlations we use the correlation coefficient, which measures closing prices over your desired period of time and range from 1 to 1: How Correlation benefits Traders Remember we're comparing the relationship between currency pairs, not currency via currency. With this in mind let's look at a USD/EUR table below. By viewing this tables we can see how we're spreading our risk (or not) when trading multiple pairs. Diversifying Risk Based on our EUR/USD Table if we had a 1 week price chart of EUR/USD and GBP/USD, they would almost be identical. We can tell this because The coefficient is 0.94 as highlighted in green. Returning to the subject of risk, we can see that opening a position in both the EUR/USD and the GBP/USD is the same as doubling up on a position, i.e. INCREASING YOUR RISK! However, we can diversify risk using this very example. We know that we shouldn't expose ourselves to more than 2% of our account, so we take up a position accordingly. a 1% long position in EUR/USD plus a 1% long position in GBP/USD = a 2% long position. In the event that the U.S. dollar sells off, the euro might be affected to a lesser extent than the pound, thus reducing risk. Pairs with >.70 correlation are good for diversifying risk (EUR/USD and GBP/USD tend to move together). The best way to diversify risk is to take positions in correlation coefficients as close to zero as possible  noncorrelating markets. This way if one pair bombs then the other one is less likely to bomb too. Before entering or increasing your positions you should fully understand your risks, position size and Scaling In. Eliminating CounterProductive Trades Utilizing correlations can help you stay out of positions that will cancel each other out. We know that EUR/USD and USD/CHF move in the opposite direction 100%. Opening a position long EUR/USD and long USD/CHF is, then, pointless and sometimes expensive. In addition to paying for the spread twice, any movement in the price would take one pair up and the other down. Confirm BreakOuts Now let's assume the other three pairs are NOT moving in the magnitude as EUR/USD. The GBP/USD is holding not falling, USD/JPY is not rising, and USD/CHF is sideways. This is usually a strong sign that the EUR/USD decline is not U.S. dollarrelated and most likely driven by some kind of negative EU news. The result is that the move up may not be sustainable, so no buy confirmation. Correlations Don't Last As mentioned in our introduction correlations can come and go over time, depending on economic and market conditions. Correlations between currency pairs can be strong or weak for days, weeks, months, or even years, they do eventually change and can change when you least expect it. Look at our EUR/USD Correlation Coefficient Table above. EUR/USD correlation with USD/CAD changes significantly within a year from an almost perfect inverse correlation to a very weak insignificant correlation and back to an almost perfect inverse correlation. Changes can be frequent and dramatic. Correlations change for many different reasons. These can include anything from changing interest rates, shifting monetary policies, changing bond spreads or any collection of economic or political events reshaping traders' sentiment on a currency. Typical Correlation Pairings After just saying that Correlations don't last, some pairings do have a general relationship with other pairings. Below we have the best positive correlating pairs:
and below we have the best negatively correlating pairs:
Where to get Correlation Charts Many Trading Platforms like MetaTrader 4 will allow access to correlation charts as do some web sites like https://fxtrade.oanda.co.uk/analysis/currencycorrelation or https://www.forexticket.co.uk/en/tools/0101correlation. They may all look a little different, but it doesn't take long to work them out. Of course you can construct your own... Constructing your own may sound hard, but it can be quite easy. Many charting packages (even some free ones) allow you to download historical daily currency prices, which you can then transport into Excel, google docs etc... In Excel, just use the correlation function, which is =CORREL(range 1, range 2). You can download Forex historical data at https://www.fxhistoricaldata.com/. Yahoo Finance also hold historical Forex & Stock Market Data. Step by step it looks like this: 1. Get the pricing data for as many currency pairs as you like. Here, I'm only using 2 for simplicity. I got this historical data from fxhistoricaldata.comTo Sum Up When you are simultaneously trading multiple currency pairs in your trading account, the most important thing is to make sure you're aware of your risk exposure. You might believe that you're spreading or diversifying your risk by trading in different pairs, but you should know that many of them tend to move in the same direction. Using these coefficients is also a good way to help confirm your hunch that prices will go in your direction. Technical analysis is not an exact science and although these ideas can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

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Introduction We've talked about correlations in Mod 7. Managing Risk  mainly around stock markets. Here we'll talk about Forex. Currency pairs can either have a positive, counter or random relationship with other currency pairs and these relationships can come and go over time, depending on economic and market conditions. Understanding these relationships, which can be viewed in correlation tables allows traders to:
To measure these currency pair correlations we use the correlation coefficient, which measures closing prices over your desired period of time and range from 1 to 1: How Correlation benefits Traders Remember we're comparing the relationship between currency pairs, not currency via currency. With this in mind let's look at a USD/EUR table below. By viewing this tables we can see how we're spreading our risk (or not) when trading multiple pairs. Diversifying Risk Based on our EUR/USD Table if we had a 1 week price chart of EUR/USD and GBP/USD, they would almost be identical. We can tell this because The coefficient is 0.94 as highlighted in green. Returning to the subject of risk, we can see that opening a position in both the EUR/USD and the GBP/USD is the same as doubling up on a position, i.e. INCREASING YOUR RISK! However, we can diversify risk using this very example. We know that we shouldn't expose ourselves to more than 2% of our account, so we take up a position accordingly. a 1% long position in EUR/USD plus a 1% long position in GBP/USD = a 2% long position. In the event that the U.S. dollar sells off, the euro might be affected to a lesser extent than the pound, thus reducing risk. Pairs with >.70 correlation are good for diversifying risk (EUR/USD and GBP/USD tend to move together). The best way to diversify risk is to take positions in correlation coefficients as close to zero as possible  noncorrelating markets. This way if one pair bombs then the other one is less likely to bomb too. Before entering or increasing your positions you should fully understand your risks, position size and Scaling In. Eliminating CounterProductive Trades Utilizing correlations can help you stay out of positions that will cancel each other out. We know that EUR/USD and USD/CHF move in the opposite direction 100%. Opening a position long EUR/USD and long USD/CHF is, then, pointless and sometimes expensive. In addition to paying for the spread twice, any movement in the price would take one pair up and the other down. Confirm BreakOuts Now let's assume the other three pairs are NOT moving in the magnitude as EUR/USD. The GBP/USD is holding not falling, USD/JPY is not rising, and USD/CHF is sideways. This is usually a strong sign that the EUR/USD decline is not U.S. dollarrelated and most likely driven by some kind of negative EU news. The result is that the move up may not be sustainable, so no buy confirmation. Correlations Don't Last As mentioned in our introduction correlations can come and go over time, depending on economic and market conditions. Correlations between currency pairs can be strong or weak for days, weeks, months, or even years, they do eventually change and can change when you least expect it. Look at our EUR/USD Correlation Coefficient Table above. EUR/USD correlation with USD/CAD changes significantly within a year from an almost perfect inverse correlation to a very weak insignificant correlation and back to an almost perfect inverse correlation. Changes can be frequent and dramatic. Correlations change for many different reasons. These can include anything from changing interest rates, shifting monetary policies, changing bond spreads or any collection of economic or political events reshaping traders' sentiment on a currency. Typical Correlation Pairings After just saying that Correlations don't last, some pairings do have a general relationship with other pairings. Below we have the best positive correlating pairs:
and below we have the best negatively correlating pairs:
Where to get Correlation Charts Many Trading Platforms like MetaTrader 4 will allow access to correlation charts as do some web sites like http://fxtrade.oanda.co.uk/analysis/currencycorrelation or http://www.forexticket.co.uk/en/tools/0101correlation. They may all look a little different, but it doesn't take long to work them out. Of course you can construct your own... Constructing your own may sound hard, but it can be quite easy. Many charting packages (even some free ones) allow you to download historical daily currency prices, which you can then transport into Excel, google docs etc... In Excel, just use the correlation function, which is =CORREL(range 1, range 2). You can download Forex historical data at http://www.fxhistoricaldata.com/. Yahoo Finance also hold historical Forex & Stock Market Data. Step by step it looks like this: 1. Get the pricing data for as many currency pairs as you like. Here, I'm only using 2 for simplicity. I got this historical data from fxhistoricaldata.comTo Sum Up When you are simultaneously trading multiple currency pairs in your trading account, the most important thing is to make sure you're aware of your risk exposure. You might believe that you're spreading or diversifying your risk by trading in different pairs, but you should know that many of them tend to move in the same direction. Using these coefficients is also a good way to help confirm your hunch that prices will go in your direction. Technical analysis is not an exact science and although these ideas can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

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