Correlation of currency pairs with each other

Assets that are used in trading in the financial market have a fundamental relationship. This is best seen by traders on Forex and other financial markets. Assets that are placed in the trading window, repeat the movement of each other. With the news on the worsening of labor market indicators in the euro area, the pair EUR / USD will start to decline in price, followed by GBP / USD, but to a lesser extent. The UK though voted for an exit from the European Union, but still depends on it.

Definition

Correlation is a term that indicates the tendency of changes between data series. Changes in one market affect the dynamics of the movement of another. Therefore, traders often use the correlation indicator of currency pairs during trading.

Kinds

Correlation of currency pairs is gliding and direct. The first gives more accurate results. In the case of direct correlation, both indicators move synchronously, and in the opposite direction they move in opposite directions.

Consider the situation on the example of trading two currency pairs: USD / CHF and EUR / USD. The trader trades with the USD / CHF instrument. If the results of the technical analysis show that there is a direct relationship between the two indicators, you can open positions in different directions. Knowledge of the relationship reduces the number of random signals. But reliable results can be achieved only when working with a large array of data. Slip or reverse correlation of currency pairs is manifested in time on the shifted data set. The change in the USD / CHF rate reflects the movement of the EUR / USD pair in the future. The more detailed information, the easier it is to build a strategy on it.

Data analysis

Calculate the correlation of currency pairs by using a special program downloaded from the Internet, or in Excel. The built-in function "CORREL" reflects the relationship between two sets of data. To determine the direct correlation, you need to use data taken from one time interval (for example, 2013), and for the reverse - from different (2013 and 2014). In the first case, the value of the indicator should be closer to "+1", and in the second - to "-1". An indicator value of "0" indicates that there is no relationship between the data.

The relationship is not permanent, because the market is changing. It is more difficult to find an inverse correlation. For example, the price of gold is more often than GBP / USD. The relationship for this pair should be calculated almost for every trading day. Some pairs move in different directions, others - in one, but with a time delay, and still others - completely copy each other. Track the dynamics of traffic is better once a month or quarter.

Applying Correlation

Traders try to avoid positions that balance each other in one time interval. For example, a trader decides to work with pairs USD / CHF and EUR / USD, which have an inverse relationship. When USD / CHF starts to fall in price, EUR / USD will grow.

It is better to refuse such combinations. The profit received from the first section may not cover the loss. The trading strategy should be based on a series of data with a direct relationship.

In financial markets, there are several currencies that have a direct correlation with the dollar: AUD / USD, GBP / USD, NZD / USD and EUR / USD. Tracking the relationship between currency pairs helps to reduce the risk of loss and in time to redirect investments to other assets.

The strategy of correlation of currency pairs

The Grail does not exist in the financial market. No strategy will be profitable at all times. Even if it is based on the correlation of currency pairs. But in the short term, you can trade based on a direct relationship. It is only necessary to find assets with a high degree of correlation (from 0.8) for the last year. The essence of pair trading is to find the points of maximum price divergence through the correlation indicator of currency pairs, sell a more expensive asset and buy cheap.

Benefits of strategy

The main advantage of the pair trading strategy is the absence of a load on the deposit. Losses of one of the correlated pairs will be blocked by profit from the other. This strategy is also called a hedge, because the second deal opens as opposed to the first one.

The second advantage is that there is no need for a fundamental or technical analysis. It is only necessary to determine the maximum divergence of pairs and not be distracted by the chaotic price movement. But this is the main minus of the strategy. Correlation between currency pairs will not continue permanently. It is impossible to determine its duration.

Indicator of correlation of currency pairs for MT4

Trading on "Forex" is usually carried out through a special platform. Most often this is MT4, less often MT5. To work on the chosen strategy, a special indicator is installed on the platform, which imposes charts of currency pairs on each other.

Especially for trading in a pair trading, you can use the OverLayChart indicator. Using it, you can determine the correlated currency pairs from the graphs. The principle of work is the following. In the platform window, you need to open a chart of any asset, for example EUR / USD, and attach OverLayChart to it. In the settings window, you should write the parameter SubSymbol the name of the correlated asset, for example GBP / USD, and choose the color of the second asset bars. If the relationship between the parameters is reversed, then in the settings window of the indicator in the parameter Mirroring should be set to true, and if the line is false.

After the indicator starts, two graphs appear in one window instead of one. Work with them can be the same as with the usual schedule: change color, timeframe, scale.

Scripts for trade

To help traders, in addition to indicators, you can also use advisors and scripts. To work on the previously discussed strategy, you can use the Correlations script, which makes it easy to find interdependent tools. In the settings you should specify:

• StartTime - the period during which the program will search for correlated tools.
• Rank is a type of relationship.

If a direct relationship is to be found between assets, the program will calculate the Pearson coefficient. To determine the inverse relationship, the Spearman coefficient is calculated. The weaker the relationship, the closer the calculated value of the indicator to "0".

After the program is launched, the interconnection search is performed using all the tools specified in the Market Review. The process itself can be observed in the left corner of the screen. Once the correlation of each other's currency pairs is found, they will be recorded in the terminal log. Even if his work is interrupted, the records will be preserved. When the work is completed, the Correlations.txt file is created, in which the results are displayed. Before running the script, you need to download the quotes history of all assets that will be analyzed.

Algorithm of trade

How is the strategy for correlation of currency pairs applied in practice? The first thing to do is to determine the inputs to the transaction, that is, to find on the chart the pairs that are maximally at variance with each other, and to calculate the number of points of this discrepancy. Next, you need to determine the average value of these deviations. On them correlation of currency pairs will be calculated. For example, the average discrepancy of assets is 80 points. This means that the next transaction will need to be opened when the discrepancy reaches 70-80 points.

No one can predict the movement of the market in the future. The preliminary analysis described above will avoid unprofitable transactions.

The rules of trade are as follows. When the calculated discrepancy is reached, two transactions must be opened at once. The more expensive asset (the one on the chart is located on top) needs to be sold, and the cheapest one - to buy. You need to exit the trades as soon as the graphs intersect at the zero point.

This strategy can be used on timeframes from 5 minutes to one hour. The greater the time difference, the less signals there will be, and the greater the profit per transaction.

Insurance

This trading strategy based on the correlation of currency pairs does not provide for the use of stop-loss or take-profit. But you can insure yourself against losses of further discrepancies with the help of pending orders. For example, a trader opened a position to buy EUR / USD when reaching 80 points of divergence. The results of preliminary analysis showed that the maximum difference between pairs was 110 points. Therefore, you can immediately open a pending order for the sale of the asset when you reach a divergence of 100 points. The same thing should be done for a cheaper pair. Open a warrant for the purchase of an asset when a difference of 100 points is reached.

Correlation in options trading

This type of trading is very similar to "Forex", but it has its own peculiarities.

If the correlation coefficient is close to "+1", then transactions in one direction can not be concluded. In case of negative changes in the market, the trader will receive a double loss. If the value of the coefficient is "-1", then you should not open transactions in different directions for the same reason. The features of trade by correlations should be used for good. That is, in order to hedge the risks, conclude deals in different directions with a positive correlation. Even if one instrument brings a loss, the second guarantees a yield with a profit.

Example: A trader made a deal to buy AUD / USD. The price began to decline. In this case, you need to conclude a deal on the correlated pair NZD / USD for sale. The profit from the second asset will cover the loss from the first.

Binary options based on the correlation of currency pairs have their own characteristics. Unlike "Forex", on them it is impossible to establish the pending order. That is, you will have to watch the changes online and stop the deal manually.

The second feature of trade comes from the first. When opening a transaction for binary options, you must immediately specify its timeframe. Therefore, you need to conduct preliminary testing of the trading strategy on the demo account or on the history of the charts.

Assets for trading

On the Internet, you can find tables that show the calculated correlation values for all popular tools. Among currency pairs, the coefficient value approximating to "+1" is observed in AUD / USD and AUD / NZD, AUD / JPY and AUD / CHF, AUD / CAD and AUD / SGD, as well as AUD / USD and NZD / USD, GBP / USD and EUR / USD, etc. Correlated are all assets that have the same currency on the first or second place.

Among the goods, a positive relationship is observed in energy carriers (OIL and GAS) and metals (GOLD and SILVER). In respect of shares, this principle is applicable to securities of companies of one industry (for example, IBM and Microsoft).

Conclusion

Correlation of currency pairs occurs when the movement of assets is interrelated. It can be unidirectional, multidirectional or parallel. At the heart of any price change is the economic interpretation. In trading in financial markets, the correlation can be used to find the entry and exit points for a trade.

The essence of the strategy, which is based on correlation, is as follows: one-way assets need to conclude deals in different directions, and on multidirectional assets - in one. Only in this case it is possible to avoid double losses and make a profit.

Hedging does not have to be used, but every trader must know the basic rules of trade.