What is currency correlation?
Currency correlation, or forex correlation, denotes the extent to which a given currency is interrelated with another, helping traders understand the price movements of currencies over time and influencing their forex decisions.
Currencies are traded in pairs, meaning no single currency pair is ever isolated. This means traders need to understand how currency pairs move in relation to others, particularly if they are trading multiple pairs at the same time.
Using currency correlation in forex trading
When using currency correlation in forex trading, traders can gain knowledge of the positions that cancel each other out, so they know to avoid those positions. Traders can also use currency pair correlation for diversifying a portfolio. More on these strategies will be discussed below.
Fx correlation is represented on a numerical scale. This ‘correlation coefficient’ ranges between -1 and +1 and shows the degree of correlation. For example, +1 would be a positive linear correlation, and implies that the two currencies will always move in the same direction. A correlation coefficient of -1 implies the currency pair will always move in the opposite direction, while if the correlation is 0, the relationship between the currencies in the pair will be random, with no correlation.
As an example, a positive correlation of, say, 0.50 between AUD/USD and EUR/USD would mean that when AUD/USD rallies, EUR/USD has also rallied 50% of the time, according to previous data. This can be observed in the charts below.
The below chart shows the currency correlation between EUR/USD (blue) andGBP/USD (red). The currency coefficient measure can be seen in the red secondary chart, revealing that while the currency pair moves in a similar direction most of the time, it is sometimes negatively correlated. The peaks represent the points in the chart showing positive correlation, with the troughs showing negative correlation.
EUR/USD-GBP/USD chart showing currency coefficient
Meanwhile, this second chart shows the currency correlation between USD/CHF (gold) and EUR/USD (blue). The currency coefficient shows that while this correlation is mainly negative, it is occasionally positively correlated.
SD/CHF-EUR/USD chart showing currency coefficient
Reading a currency correlation table
Currency correlation tables show the relationship between main forex pairs and other pairs over different time periods but, as seen in the charts above, currency correlations can and do change over time.
For example, the following table shows GBP/USD against five prominent currency pairs over a sample of 20 days, 60 days and 90 days:
GBP/USD and USD/CHF, as an example, shows a positive correlation over the shorter timeframe of 20 days. However, the pairing is overall regarded as a negative correlation for similar reasons to USD/CHF and EUR/USD. CHF is a safe haven currency and can appreciate dramatically when economic turmoil hits and equities fall, which is one reason that might explain the negative figures.
Why traders use currency correlation