PRACTICAL USE of the Correlation Theory
This article is focused on explaining how currency correlations can be used in a very practical way. Our goal is not to dive into theory or theoretical models but show how correlations can help solve practical trading-related decisions.
The Forex Correlation Theory has many practical advantages such as confirming an entry, avoiding false break out, filtering worse setups, identifying which currency is trending, and reviewing crosses for a dynamic view. This article reviews the perfect correlation setup.
FILTERING OUT & CONFIRMING FOREX TRADES
The forex correlation theory can be used as a method to filter out trade setups which have a worse probability versus reward-risk ratio. The process how a trader can utilize the concept tool is as follows:
EUR/USD – long
GPB/USD – long
NZD/USD – long
AUD/USD – long
USD/CAD – short
USD/JPY – long
5 of the six are going in the same direction, the USD/JPY in this case is in negative correlation to the other five.
For this trade – USP/JPY long with a stop loss of 40 pips and a limit of 60 pips.
Forum on trading, automated trading systems and testing trading strategies
Multi currency EA ideas
Sergey Golubev, 2014.02.26 13:23
Multi currency EA may be based on some other systems. The only thing to do (except the system itself) is 'account protection feature'. Because those kind of EAs may be risky, and this risk is for whole the account (just my opinion sorry). But it also depends on how it will be coded for example.
As to correlation so I found the following
Indicators: MFCS Currency Correlation Chart
Sergey Golubev, 2013.10.26 09:29
Currency Pairs Correlation in Forex Market: Cross Currency Pairs
As a forex trader, if you check several different currency pairs to find the trade setups, you should be aware of the currency pairs correlation, because of two main reasons:
1- You avoid taking the same position with several correlated
currency pairs at the same time and so you do not multiply your risk.
Additionally, you avoid taking the positions with the currency pairs
that move against each other, at the same time. 2- If you know the
currency pairs correlations, it may help you to predict the direction
and movement of a currency pair, through the signals that you see on the other correlated currency pairs.
Now I explain how currency pairs correlation helps. Lets start with the 4 major currency pairs: EURUSD ; GBPUSD ; USDJPY and USDCHF.
In both of the first two currency pairs (EURUSD and GBPUSD), USD
works as the money. As you know, the first currency in currency pairs is
known as the commodity and the second one is the money. So when you buy
EURUSD, it means you pay USD to buy Euro. In EURUSD and GBPUSD, the
currency that works as the money is the same (USD). The commodity of
these pairs are both related to two big European economies. These two
currencies are highly connected and related to each other and in 99% of
the cases they move on the same direction and form the same buy/sell
signals. Just recently, because of the economy crisis, they moved a
little differently but their main bias is still the same.
What does it mean? It means if EURUSD shows a buy signal, GBPUSD
should also show a buy signal with minor differences in the strength and
shape of the signal. If you analyze the market and you come to this
conclusion that you should go short with EURUSD and at the same time you
decided to go long with GBPUSD, it means something is wrong with your
analysis and one of your analysis is wrong. So you should not take any
position until you see the same signal in both of these pairs. Of
course, when these pairs really show two different direction (which
rarely happens), it will be a signal to trade EUR-GBP. I will tell you
and USDJPY behave so similar but not as similar as EURUSD and GBPUSD,
because in USD-CHF and USDJPY, money is different. Swiss Franc and
Japanese Yen have some similarities because both of them belong to oil
consumer countries but the volume of industrial trades in Japan, makes
Generally, when you analyze the four major currency pairs, if you see
buy signals in EURUSD and GBPUSD, you should see sell signals in
USDJPY. If you also see a sell signal in USD-CHF, then your analysis is
more reliable. Otherwise, you have to revise and redo your analysis.
EURUSD, GBPUSD, AUDUSD, NZDUSD, GBPJPY,
EURJPY, AUDJPY and NZDJPY usually have the same direction. Just their
movement pattern sometimes becomes more similar to each other and
What do I prefer?
If I find a sell signal with EURUSD and GBPUSD and a buy signal with
USDJPY, I prefer to take the short position with one of the EURUSD or
GBPUSD because downward movements are usually stronger. I will not take
the short position with EURUSD or GBPUSD and the long position with
USDJPY at the same time, because if any of these positions goes against
me, the other one will do the same. So I don’t double my risk by taking
two opposite positions with two currency pairs that move against each
How to use the currency pairs correlation to predict the direction of the market?
When I have a signal with a pair, but I need confirmation to take the
position, I refer to the correlated currency pairs or cross currency
pairs and look for the confirmation. For example I see a MACD Divergence in USDCAD
four hours chart but there is no close support breakout in USDCAD four
hours or one hour chart. I want to take a short position but I just need
a confirmation. If I wait for the confirmation, it can become too late
and I may miss the chance. I check a correlated currency pair like
USDSGD and if I see a support breakout in it, I take the short position
with USDCAD. Now the question is why I don’t take the short position
with USDSGD and I use its support breakout to go short with USDCAD? I do
it because USDCAD movements are stronger and more profitable. I use
USDSGD just as an indicator to trade USCAD.
It happens that you take a position with a currency pair, but it
doesn’t work properly and you don’t know if it was a good decision or
not. On the other hand, you don’t see any sharp signal on that currency
pair to help you decide if you want to keep the position or close it. In
such cases, you can check a correlated currency pair and look for a
continuation or reversal signal. It helps you to decide about the
position you have.
Sometimes, some correlated currency pairs don’t move in the way that
they are supposed to move. For example EURUSD and USDJPY go up at the
same time, whereas they usually move against each other. It can happen
when Euro value goes up and USD value doesn’t have a significant change,
but at the same time JPY value goes down, because of some reason. In
these cases, you can use the below table to find and trade the currency
pair that its movement is intensified by an unusual movement in two
other currency pairs. In this example, if EURUSD and USDJPY go up at the
same time, EURJPY will go up much stronger (see the below chart).
Or if EURUSD goes up and AUDUSD goes down at the same time, EUR-AUD goes up strongly.
Another important example: If EURUSD goes up and GBPUSD goes down at the same time, EURGBP
goes up strongly. Maybe this is the most important case that we can
trade based on this rule. It happens many times that EURUSD and GBPUSD
move against each other and that is the best time to trade EURGBP. Now
you know why EURGBP doesn’t move strongly most of the time. It is
because EURUSD and GBPUSD move in the same direction most of the time.
For example they go up at the same time and so EURGBP doesn’t show any
significant movement because when both of the currencies of a currency
pair go up or down at the same time, that currency pair doesn’t show any
strong movement and direction (I hope you know why a currency pair goes
up or down. It goes up when the first currency value goes up OR the
second currency value goes down. For example EURUSD goes up, if Euro
value goes up or USD value goes down. If this happens at the same time,
then EURUSD goes up much stronger).
The below chart includes almost all of these unusual movements and their results on the third currency pair.
if EURUSD and USDJPY then EURJPY means if EURUSD and USDJPY go up at the same time, then EURJPY goes up much stronger.
Sergey Golubev, 2014.02.04 08:27
Trade Gold Using Currency Correlations (based on dailyfx article)
Secondly, the AUD has a high correlation to gold due to Australia’s
extensive gold mining operations. As gold prices fluctuate, this
increases or decreases the amount of funds transferred into AUD to make
purchases of the metal. These transfers essentially change demand for
the currency and can directly cause changes in the AUDUSD currency pair
Trading the Correlation
The key to trading positively correlated assets, is finding a direction
from one of the underlying assets before making a trading decision. If
traders are seeing the AUDUSD push to lower lows, this could easily be
the catalyst for a bearish bias on Gold. Conversely if gold is trending
upwards, this can also be a signal of a new uptrend on the AUDUSD.
As you can see, this information is very useful to traders that have a
general fundamental view of the market. If you have an opinion on Gold
or the US Dollar this can be relayed into a trade idea. Often traders
that are bullish on Gold choose to trade the AUDUSD instead of the metal
itself. The Aussie Dollar carries a 2.50% banking rate, meaning traders
can earn additional interest while executing a buy order on a
positively correlated opinion of Gold. If a trader is bearish on the
AUDUSD currency pair, traders can in turn sell gold to avoid
accumulating interest on their trading balance.
Sergey Golubev, 2014.02.04 09:27
Australian Dollar Strongly Correlated to Gold, Silver, Steel Prices (based on this article)
View forex correlations to the SPDR Gold ETF Trust
(GLD), United States Oil Fund ETF (USO), SPDR Dow Jones Industrial
Average ETF Trust (DIA), UK FTSE 100 Index, and IShares Silver Trust ETF
Thanks for the very informative topic. I just started with correlations and feel this is a very important subject to master.
I don't get it completely when it is to avoid false breakouts or confirming an entry. Do I have simply to find an instrument that is usually correlated and verify the move is the same? Is it better to make this verification on more correlated instruments?
Heres some quick examples:
EURAUD * AUDUSD = EURUSD1.4065 * 0.9335 = 1.3130EURCAD / USDCAD = EURUSD1.4273 / 1.0870 = 1.3130EURCHF / USDCHF = EURUSD1.2070 / 0.9192 = 1.3130EURGBP * GBPUSD = EURUSD0.7903 * 1.6613 = 1.3130EURJPY / USDJPY = EURUSD137.01 / 104.34 = 1.3130
Look guys, I spent 5 years developing EA strategies based on merely all types of correlations.., and would be very surprised if it can generate any reasonable sustainable profits in a long run.
Free advice - don't waste your time.