Forex Correlation Indicator – Rules to Follow in Correlation Trading
Today on our Best MT4 Indicators website we will do an interesting forex correlation indicator article. Many traders like the complication and dynamics of the forex market. Nevertheless, to thrive and succeed in such a market, you need to understand the complexities in it. One of such intricacies is currency correlations. In this article, you will learn what forex currency correlation entails and the best approach to using it to your advantage without using a forex correlation indicator.
Correlation in Forex Trading
One central thing in the forex market is the fact that currencies get traded in pairs, which makes them dependent on each other. This dependency on each other is called correlations; traders use these correlations to understand the movement of price over time. Every currency relies on another, making it easier for traders to decide which direction to trade.
Today, many hapless traders who don’t understand the interconnection of currencies are always receiving the bitter end of the stick by losing trade consistently. Correlations provide traders with considerable opportunities to make a profit. Additionally, the professionals use it to hedge their forex positions while minimizing their exposure to risk.
However, if you wrongly analyze the market trading currency correlations or peradventure the market goes in an unexpected direction, the likelihood of you incurring a loss is high. Although traders use forex correlation indicator; however, understanding the trading time and current trading volume affects currency correlation is crucial.
For instance, currency pairs with the US dollar (whether as base or quote) tend to be very active from 12pm to 9pm (UK time). Therefore, finding the time the market is more active in relation to the currency pair must be your priority.
Trading Forex Correlation Pairs
Trading shouldn’t be a labyrinth that requires someone with a super brain to understanding the tricks. However, when it comes to trading correlation pairs, the first step is to identify pairs that relate positively or negatively. In a traditional sense, you would open two opposing positions if the currency correlation was negative and same if it were positive.
If you are new to trading, it might sound not very clear but here is the idea behind the statement mentioned above. Assuming you open a long position on USD/CAD and the market keep selling, instead of losing, you can open any position on AUD/USD on buy since they are correlated. Both pairs will cancel each other since they move in the opposite direction.
The essence of opening positions on correlated pairs is to diversify their trades while maintaining the overall direction of the market. It could be to protect their account if a particular currency moves against them as they will have the opportunity to accumulate little profit from the other. However, as good as it sounds, there is that element of uncertainty in trading.
Rules to Trading currency Correlation
Every trading strategy has its rule, and currency correlation isn’t different. It is never enough to rely on a single top forex indicator, with no indicator been perfect including Forex correlation indicator. However, abiding by these rules, you can increase your chances of success when trading currency correlation.
Avoid trading opposite currency pairs
Never go against this rule as it is the foundation of currency correlation trading. Never trade currency pairs that contradict one another. For example, trading the EUR/USD and USD/CHF pairs. Both pairs move in opposite directions almost all time.
In other words, when one is going up, the other is coming down. It is hard making reasonable profit trading these pairs; it is better to find pairs that correlate.
Spread and diversification
Traders use currency correlation to manage and hedge their investments; for instance, opening multiple short positions on a particular currency pair, when the market goes against your direction, you suffer enormous consequences. Remember, currency pairs such as AUD/USD and EUR/USD have positive correlation – they go in the same direction.
Assuming you are expecting the European Central Bank meeting to affect the price of EUR/USD pair. However, instead of opening numerous positions on EUR/USD, you can buy some AUD/USD and also EUR/USD. By doing this, you have diversified your positions while mitigating any possible losses.
Implement Pips into trading
A pip is the smallest change in the price of a currency pair. Let us use an example to explain it. Remember the correction of USD/CHF and EUR/USD; they have a strong negative correlation. For instance, you observe EUR/USD is on long against your expectation of short. To mitigate your losses, you can open another position (USD/CHF) and go long.
However, if you are new to forex trading, it is better to understand risk management because that is when you can see the broader picture of these tactics.
Correlated commodities with Currencies
Forex currencies pairs are not only related to one another; at times, commodities can be correlated with currencies pairs. In this part, we will briefly look at two commodities correlated with currency pairs
Crude Oil and CAD
The Canadian dollar is positively correlated with Crude oil. Usually, if the price of crude oil increases, the value of the Canadian dollars also goes up on the forex market. Most times, it is reflected in the USD/CAD pair because crude oil is traded in the US dollar.
You don’t need a forex correlation indicator to know that when the price of oil increases, the price of the US dollar will decrease. Yes, it is antagonistic to each other, and many forex traders tend to leverage on this.
Gold and AUD
While the price of Oil and CAD are correlated, another correlated commodity with currency is Gold and AUD. The correlation between gold and AUD is widely reflected in the AUD/USD currency pair. Since Australia is a massive exporter of gold and priced in the US dollar, when its price depreciates, the price of AUD/USD depreciates. Alternatively, if gold is selling, then the AUD/USD also goes that way.
Summary of Forex Correlation Indicator
The currency correlation is an indispensable trading strategy many traders use to protect their account. Importantly, it can be negative or positive; in negative correlations, both currency pairs move in the same direction while a positive correlation means they move in opposite directions.
Notwithstanding, they offer considerable opportunities to hedge your exposure or realize tremendous profits. While traders can use forex correlation indicator, the goal is to trade with a proper risk management place. Furthermore, currency correlation isn’t only in the forex market but affects the commodity market.
What trading strategy are you using? Do you think a forex correlation indicator can help increase your profit? Whatever the case, we have essential tools to make your trading easy and profitable, so look at this link for more. Next week we will share an interesting mt4 spread indicator article.
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