How To Trade Currency Pair Correlations In Forex - IG

What is currency correlation in forex?

A currency correlation in forex is a positive or negative relationship between two separate currency pairs. A positive correlation means that two currency pairs move in tandem, and a negative correlation means that they move in opposite directions.

Correlations can provide opportunities to realise a greater profit, or they can be used to hedge your forex positions and exposure to risk. If you can be certain that one currency pair will move alongside or against another, then you can either open another position to maximise your profits, or you could open another position to hedge your current exposure in case volatility increases in the market.

However, if your forecasts are wrong when trading currency correlations, or if the markets move in an unexpected way, you could incur a steeper loss, or your hedge could be less effective than anticipated.

The strength of a currency correlation depends on the time of day, and the current trading volumes in the markets for both currency pairs. For example, pairs which include the US dollar will often be more active during the US market hours of 12pm to 9pm (UK time), and pairs with the euro or the pound will be more active between 8am and 4pm (UK time) – when the European and British markets are open.

Learn more about the best times to trade forex

What is the correlation coefficient?

The correlation coefficient is used in pairs trading, and it measures the correlation between different assets – in this case, currency pairs. It ranges from 1 to -1, with 1 representing a perfect positive correlation and -1 representing a perfect negative correlation. If the coefficient value is 0, it means that there is no correlation between the price movements of different currency pairs.

The Pearson correlation coefficient is the most used measure of currency correlations in the forex market, but others include the intraclass correlation and the rank correlation. In the context of currency correlations, the Pearson correlation coefficient is a measure of the strength of a linear relationship between two different forex pairs. Many traders will use a spreadsheet computer program to calculate the Pearson correlation coefficient, because the method for doing so manually is very complex.

What are the most highly correlated currency pairs?

The most highly correlated currency pairs are usually those with close economic ties. For example, EUR/USD and GBP/USD are often positively correlated because of the close relationship between the euro and the British pound – including their geographic proximity, and their status as two of the world’s most widely-held reserve currencies.

The table below gives examples of the correlations between some of the most traded currencies in the world. The correlations were calculated over a one-day period on 26 November 2019 using the Pearson correlation coefficient: