Understanding forex pairs correlation – or how currency pairs move in relation to each other, is critical for all forex traders.
Correlation describes how currencies are related or connected to each other, and move in relation to each other.
The reason this is important is so you can avoid the risk of inadvertently ‘putting all your eggs in one basket.’
Trading too many correlated markets at the same time is a common error that beginner traders make.
What exactly is forex pairs correlation?
Correlation in FX trading refers to how currency pairs move in relation to each other or other markets such as oil, gold, or the S&P 500 index.
The word ‘correlation’ means ‘a connection between two or more things.’
Understanding forex pairs correlation can help traders better manage their exposure to currency movement, and so make smarter trading decisions.
It’s like knowing how different parts of a machine work together.
How does negative correlation in forex pairs work?
Imagine you’re watching two friends walk together. When they walk in the same direction, they’re positively correlated.
If one walks forward while the other walks backward, they’re negatively correlated. And if they walk independently, they’re uncorrelated.
Similarly, in forex, some currency pairs tend to move together, meaning when one goes up, the other usually does too. This is called positive correlation.
Here is a chart displaying EUR/USD, GBP/USD, and AUD/USD. You can see all three pairs move together, meaning they are positively correlated.
On the other hand, some pairs move in opposite directions, so when one goes up, the other goes down. This is called negative correlation.
Here is a chart showing EUR/USD and USD/JPY. You can see the pairs move in the opposite direction at the same time, meaning they are negatively correlated.
Some pairs move independently of each other in a completely random direction, so they have little or no correlation.
You can see here, there is only limited correlation between EUR/GBP and AUD/NZD:
Why is correlation important to FX traders?
Understanding correlation is crucial for several reasons:
- Risk management: Understanding forex pairs correlation helps traders lower their risk by diversifying which currencies they trade together. This helps traders avoid ‘putting all their eggs into one basket,’ which is known as over-concentration risk.
- Portfolio optimisation: It helps traders build a balanced portfolio by picking currency pairs that won’t all move together in the same direction in response to the same item of news.
- Using correlation as a trading strategy: Traders use correlation to find trends or reversals, helping them decide when to buy or sell. For example, the price movements in oil and USD/CAD can be correlated, so oil can act as a leading indicator for the Canadian dollar.
- Market sentiment assessment: Correlation patterns can provide valuable insights into market sentiment. For example, high positive correlation among safe-haven currencies during a period of uncertainty can indicate risk aversion in the market.
How do FX traders measure correlation?
FX traders measure correlation using various tools.
One common method is by using correlation coefficients, which are numbers that quantify the strength and direction of the relationship between currency pairs.
These correlation coefficients range from -100 to +100, where:
- +100 indicates perfect positive correlation (pairs move together)
- -100 indicates perfect negative correlation (pairs move opposite each other)
- 0 indicates no correlation (pairs move independently of each other).
The higher the coefficient number, the stronger the relationship between the two currencies.
Traders can also use correlation matrices or trading charts to visually represent correlation relationships between multiple currency pairs.
Forex correlation pairs list
Naturally as forex traders we want to know ‘what are the most common currency correlations?’
Here’s a handy forex correlation pairs list to refer to, or use as a cheat sheet:
Positive correlations
These pairs tend to move in the same direction:
- EUR/USD and GBP/USD: Both are major currency pairs and often move together due to their shared reliance on the US dollar.
- AUD/USD and NZD/USD: Both are commodity currency pairs, and their prices are influenced by similar factors like commodity prices and risk sentiment.
- USD/CAD and USD/CHF: Both have an inverse relationship with the US dollar, meaning they tend to move in the opposite direction to the movements of the dollar index.
Negative correlations
These pairs move in opposite directions:
- USD/JPY and EUR/JPY: USD/JPY is negatively correlated with EUR/JPY due to the contrasting monetary policies of the US Federal Reserve and the European Central Bank.
- AUD/USD and USD/JPY: These pairs are negatively correlated, as the Australian dollar is considered a risk currency, while the Japanese yen is a safe-haven currency.
Weak or no correlation
Some pairs move independently of each other:
- GBP/USD and USD/CHF: These pairs may exhibit weak or no correlation due to distinct economic factors and geopolitical influences.
- GBP/USD and USD/CHF: While their correlation might be weak at times, it’s not necessarily always absent.
They can exhibit some degree of positive correlation, especially during periods of global risk aversion, as both the British pound and Swiss franc can act as safe-haven currencies to an extent.
Positive and negative correlations
It’s important to remember that:
- Currency correlations are not static: Like a dancing couple, the bond between two currencies can change over time due to various factors like economic policy changes, global events, and market sentiment.
- These are generalisations: Real-world relationships between currencies are complex, and influenced by numerous factors beyond what’s mentioned here. You should always check the current currency correlation before opening a new position.
- Correlation doesn’t imply causation: This means just because two things move together, it doesn’t mean one causes the other. For example, two roosters crowing together at dawn doesn’t cause the sun to rise.
Understanding correlation is essential to proper risk management
By understanding which forex pairs correlate, you won’t unintentionally end up with similar positions that move together based on the same factors.
This will reduce your risk of being over-exposed to a news event or announcement that will affect all your open positions the same way.
Additionally it will:
- ensure better portfolio diversification
- help you make more informed trading decisions
- assist you to better assess market sentiment
For these reasons, you should keep currency pair correlation front-of-mind when making your trade selections.
I hope you’ve found this information useful!
Till next time, happy trading!
If you like this article then sign-up for our newsletter or join over 42,000 traders and get The Advanced Forex Course for Smart Traders 2.0. It’s 100% free.
Sources
Marketmates uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial guidelines to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
- Dr Van K. Tharp – Super Trader: Make consistent profits in good and bad markets. https://www.amazon.com.au/Super-Trader-Expanded-Van-Tharp
- Sam Eder – The Consistent Trader. https://www.amazon.com.au/Consistent-Trader-Winning-Trading-Psychology/
- Investopedia – How to use currency correlations to your advantage https://www.investopedia.com/trading/using-currency-correlations-advantage/
