Forum on trading, automated trading systems and testing trading strategies
Indicators: Pearson correlation indicator
Sergey Golubev, 2014.02.07 13:08
Trade Oil with Currency Correlations (based on dailyfx article)
Understanding market correlations can allow traders to have an option on
a commodity based off of the direction of their favorite currency pair.
The idea is to take two seemingly different markets or assets and see
how market price moves relative to each other. Today we will review
using the USDCAD currency pair to determine the direction of USOIL (WTI)
through the use of a correlation.
When someone mentions Oil, currency traders should immediately think of
the USDCAD as a correlating currency pair. These assets are negatively
correlated meaning they generally can be seen moving in opposing
directions. This occurs because the USDCAD quotes the price of Canadian
Dollars in terms of USDollars. USOil represents Oil per barrel priced in
terms of US Dollars. With the USD being on opposing sides of each
equation this means that the two assets will move in opposing directions
when the USD strengthens or weakens.
Secondly, the CAD has a high correlation to Oil due to Canada’s
extensive oil deposits. Most of this oil is purchased by the US causing a
transfer of funds along the way. As oil prices fluctuate, this
increases or decreases the amount of funds transferred from USD to make
purchases of Canadian resourses. These transfers essentially change
demand for the currency and can directly cause changes in the USDCAD
currency pair as well.
Trading the Correlation
The key to trading negatively correlated assets is finding a direction
or having a fundamental opinion from one of the underlying assets before
making a trading decision. If traders are seeing the USDCAD push to
higher highs, this could easily be the catalyst for a bearish bias on
Oil. Conversely if Oil is trending upwards traders would have reasonable
expectations of the USDCAD traveling towards lower lows.
As you can see, this information is very useful to traders that already
have an opinion on either Oil or the USDCAD currency pair. Often traders
that are bullish on Oil choose to trade the USDCAD instead of the metal
itself. The Canadian Dollar carries a 1.00% banking rate, meaning
traders can earn additional interest while trading a bullish bias on
Oil. If a trader is bullish on the USDCAD currency pair, traders can in
turn sell Oil to avoid accumulating interest on their trading balance.