Currency correlation simply refers to the relationship between the value of two different currency pairs.
It helps traders understand how one currency pair moves in relation to another. Positive correlation means the pairs move in the same direction, while negative correlation means they move in opposite directions.
As a forex prop trader, it is vital that you know which currency pair correlates with which pair so you can utilize the knowledge effectively when making trading decisions.
In this blog post, we want to explore the benefits of currency pair correlation; reasons why you should consider using it (before you trade):
Counterproductive trading is when you enter two or more trades that cancel each other out or reduce your profit. If you are trading two currency pairs that are highly correlated, you need to be careful not to enter two positions that can “negate” each other. For instance, if you know EUR/USD and USD/CHF are negatively correlated, then the two positions will offset each other, and you will make no profit.
You can also use currency pair correlations to leverage your profits. For example, if you know EUR/USD and EUR/SGD are positively correlated, then if you have a bullish view on the EUR/USD pair, you can also trade the EUR/SGD pair. By trading both pairs, you can double your exposure to the euro and increase your potential profit.
Another benefit of using currency correlation is that it can help you diversify your risk by hedging your positions. Hedging is a strategy that involves taking an opposite or offsetting position to reduce your exposure to a certain risk. For instance, if you are long on EUR/USD, you are exposed to the risk of the euro depreciating against the US dollar.
To hedge this risk, you can take a short position on another pair that you think is positively correlated with EUR/USD. This way, if the euro falls against the US dollar, you can offset some of your losses with the profits from your short position.
Currency correlation can also help you confirm your trading signals and avoid false breakouts or fakeouts. To confirm a breakout and avoid a fakeout, you can use correlated pairs to validate your trading signal. For example, if you see a breakout on EUR/USD, you can check if the same breakout is happening on other pairs that you know are positively correlated with EUR/USD.
If the breakout is confirmed by multiple pairs, it is more likely to be a genuine breakout and a valid trading signal. However, if the breakout is not confirmed by other pairs or if it is contradicted by correlated pairs, it is more likely to be a fakeout signal.
In conclusion, currency pair correlation can be a great tool for successful prop trading. If prop traders understand the relationship between different currency pairs, they can gain valuable insights into market dynamics, make more informed trading decisions, and better manage their risk exposure to maximize their profits.
However, you should also be aware that trading correlated pairs is not without risk. You should always use proper risk management techniques, such as stop-loss orders and position sizing, to protect your account from unexpected market movements.