Specialize In Trading US Dollar (Part II)
Suppose you have the data for the currency correlations of the major pairs. The correlation between GBP/USD and EUR/USD is 0.68. It means that both the pairs move in the same direction 68% of the time.
USD/CHF and EUR/USD have a correlation coefficient of -0.975 and is pretty close to minus one. The negative correlation coefficient means both USD/CHF and EUR/USD pairs move in the opposite direction almost 97.5% of the time. In other words, if USD/CHF moves up, the pair EUR/USD will move down!
You have this information about the recent correlation coefficients. It tells you how much these pairs move in the same direction or opposite direction. Suppose you trade both the currency pairs USD/CHF and EUR/USD by going long. What you will be doing by going long on both the positively correlated pairs is in fact canceling both the long positions.
If you win on USD/CHF, you will lose on EUR/USD and vice versa. The two trades would effectively cancel each other due to the negative correlation between the two pairs. A savvy investor would go long on USD/CHF and go short on EUR/USD. So you are shorting USD in both the trades and diversifying the USD bearish investment.
Currency correlations can help you in making entry and exit decisions for each trade. Lets suppose GBP/USD starts showing volatility. The pair approaches a resistance level. You plan on going long if there is a breakout.
However, you notice on the charts that the other three major currency pairs are not showing volatility and moving as much as the GBP/USD. EUR/USD is not showing volatility and moving up on the chart. USD/CHF is not showing much volatility and moving down on the chart. USD/JPY is also not showing much volatility and not moving down on the chart. This means that the volatility in GBP/USD is solely GBP driven. The move is maybe related to some news in the British economy about Bank of England raising or lowering interest rates or some big companies merging.
Now you know that the move in GBP/USD pair is Pound driven. It is not US Dollar driven. You can take advantage of this information. Ignore the GBP driven move and dont enter into any trade. Wait for a later opportunity that involves simultaneous correlated moves of all the major pairs.
Lets take another example. Suppose you have taken a short position on EUR/USD pair. You want to be sure whether the pair will proceed down towards your profit target. You also want to know can it go against you and cause you to exit the trade with a small loss.
Your EUR/USD has broken the S1 support pivot level and heading towards M1. By looking at the pair EUR/GBP, you find that it has paused at its S1 support pivot level and is showing signs of reversing to the upside.
Knowledge of currency correlations can help you a lot now. It can tell you if EUR/GBP breaks through the S1 level, you are poised for a profitable trade in this type of a situation, However, you should watch the indicators. Exit before taking a big loss if EUR/GBP reverses and heads back to the upside. You might consider trading a basket of all the major currencies as you mature in forex trading. - 23199
USD/CHF and EUR/USD have a correlation coefficient of -0.975 and is pretty close to minus one. The negative correlation coefficient means both USD/CHF and EUR/USD pairs move in the opposite direction almost 97.5% of the time. In other words, if USD/CHF moves up, the pair EUR/USD will move down!
You have this information about the recent correlation coefficients. It tells you how much these pairs move in the same direction or opposite direction. Suppose you trade both the currency pairs USD/CHF and EUR/USD by going long. What you will be doing by going long on both the positively correlated pairs is in fact canceling both the long positions.
If you win on USD/CHF, you will lose on EUR/USD and vice versa. The two trades would effectively cancel each other due to the negative correlation between the two pairs. A savvy investor would go long on USD/CHF and go short on EUR/USD. So you are shorting USD in both the trades and diversifying the USD bearish investment.
Currency correlations can help you in making entry and exit decisions for each trade. Lets suppose GBP/USD starts showing volatility. The pair approaches a resistance level. You plan on going long if there is a breakout.
However, you notice on the charts that the other three major currency pairs are not showing volatility and moving as much as the GBP/USD. EUR/USD is not showing volatility and moving up on the chart. USD/CHF is not showing much volatility and moving down on the chart. USD/JPY is also not showing much volatility and not moving down on the chart. This means that the volatility in GBP/USD is solely GBP driven. The move is maybe related to some news in the British economy about Bank of England raising or lowering interest rates or some big companies merging.
Now you know that the move in GBP/USD pair is Pound driven. It is not US Dollar driven. You can take advantage of this information. Ignore the GBP driven move and dont enter into any trade. Wait for a later opportunity that involves simultaneous correlated moves of all the major pairs.
Lets take another example. Suppose you have taken a short position on EUR/USD pair. You want to be sure whether the pair will proceed down towards your profit target. You also want to know can it go against you and cause you to exit the trade with a small loss.
Your EUR/USD has broken the S1 support pivot level and heading towards M1. By looking at the pair EUR/GBP, you find that it has paused at its S1 support pivot level and is showing signs of reversing to the upside.
Knowledge of currency correlations can help you a lot now. It can tell you if EUR/GBP breaks through the S1 level, you are poised for a profitable trade in this type of a situation, However, you should watch the indicators. Exit before taking a big loss if EUR/GBP reverses and heads back to the upside. You might consider trading a basket of all the major currencies as you mature in forex trading. - 23199
About the Author:
Mr. Ahmad Hassam is a Harvard University Graduate. He is interested in day trading and swing trading stocks and currencies. Learn Forex Nitty Gritty. Try Netpicks Forex Signal Service.
posted by X - Men @ 4:12 AM
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