CORRELATION
Currency Correlation Matrix
Avoid over-exposure. Positive values mean pairs move together (Risk Concentration). Negative values mean pairs move in opposite directions (Hedging).
Mastering Risk with Correlation Analysis
The Trap of "Doubling Down"
Many traders unknowingly double their risk by opening positions in highly correlated pairs. For example, EUR/USD and GBP/USD often have a positive correlation above +0.85.
The Risk: If you Buy EUR/USD and Buy GBP/USD simultaneously, you aren't diversifying. You are essentially taking one giant position against the US Dollar. If the Dollar strengthens, you lose on both trades instantly.
Hedging with Negative Correlation
Negative correlation (e.g., -0.90) implies pairs move in exact opposites. Historically, EUR/USD and USD/CHF are strongly negatively correlated because the Swiss Franc often tracks the Euro, but the USD is on the opposite side of the pair.
The Hedge: Buying EUR/USD and Buying USD/CHF is a "Perfect Hedge." As one goes up, the other goes down, locking your PnL in place (minus spreads). This is useful for stabilizing a portfolio during volatile news events.
Normally, AUD/USD and NZD/USD move together (+0.90 correlation) due to regional proximity.
The Signal: If the correlation suddenly drops (e.g., to +0.20) or price action diverges significantly (one rallies, one falls), it indicates a specific fundamental shift in one currency.
The Trade: Traders often wait for the "Snap-Back," betting that the pair that lagged behind will eventually catch up to its partner to restore the historical correlation.
Reading the Coefficients (Pearson Scale)
- +0.80 to +1.00: Extremely Strong Positive (Pairs move together). Avoid trading same direction.
- +0.50 to +0.79: Moderate Positive.
- 0.00 to 0.49: No significant correlation (Random). Good for diversification.
- -0.80 to -1.00: Extremely Strong Negative (Pairs move opposite). Good for hedging.