By Fabiano Trevisiol
The correlations between currencies in forex, everythin you need to know.
The mechanism of correlations between currencies is an important knowledge that can help you make informed decisions in everyday trading, also know this topic allows you to have a much clearer vision on forex market making trading much more conscious and correct.
In the forex market will perform operations on couples or currency crosses. One will be the long side, purchased, the other short side, sold.
Take for example the Euro Dollar pair EUR/USD. The Euro is the currency in the first place, is also called uniform treated base or denominator, while the dollar is the currency listed also called variable or numerator. The base currency is the one that presents the highest value.
In this picture we see for example the graph representing the exchange rates between the British pound and US dollar GBP/USD
If the US dollar strengthens, the exchange rate drops, if it weakens, the exchange rate rises.
The currency pairs or hybrids may have in common the numerator or denominator, treated or base currency or divided variable or quoted.
The different forex pairs are related to each other in a way I would say math, especially many couples have in common or uniform or variable process are moving about in the same way direct correlation, or not, inverse correlation.
We take some of the major pairs:
|EUR/USD||Eur/US Dollar||EUR o Fiber|
|AUD/USD||Australian Dollar/US Dollar||Aussie|
|GBP/USD||English Pound/US Dollar||Cable|
|NZD/USD||New Zealand Dollar/US Dollar||Kiwi|
|USD/CHF||US Dollar/Swiss Franc||Chief o Swissy|
|USD/CAD||US Dollar/Canadian Dollar||Loonie|
|USD/JPY||US Dollar/Japan Yen||Yen|
These 7 currency pairs are traded for trading and are called Majors, all have in common is the US dollar, in some cases in the first place, namely how divided or, in other cases treated as variable or quoted, in second place.
In the currency market, the US dollar is the reference for any transaction. It is so high the importance of the dollar, which itself did not exist it would not be possible to change the Euro with other currencies such as the Australian dollar or JPY Japanese Yen, then we will better the reason for this claim.
When pairs have the same denominator or currency trades, tend to have all the same direction, they are positively related. For example, if EUR/USD tends to rise, it is likely that the same thing happens to GBP/USD or AUD/USD or NZD/USD
Here is an example of positive correlation:
In addition, EUR/USD and GBP/USD has a very high correlation and similarly NZD/USD and AUD/USD between them are very related, this also depends on the fact that these subsets are moved from macroeconomic events such as are found in similar geographic areas.
When instead on two different currency pairs we in a case in the first place, namely as the denominator or base currency or, in the second case, treated as the quoted currency or variable or common denominator, we’ll be in a situation of negative correlation. An example is the EUR/USD and USD/CHF
Here is an example of negative correlation:
Pair made between majors are defined cross, in these cases, you use the common currency the US dollar, and by subtraction yields the cross listing.
We see in Practice.
EUR/USD with AUD/USD = Cross EUR/AUD
EUR/AUD is a cross, a cross given by 2 major and its share price is the difference between the 2 major.
If for example in a day of trading EUR/USD went upwards of 50 pips and AUD/USD and went upwards of 80 pips.
EUR/AUD will decrease by 30 pips, which is the difference of the 2 major movements.
If the US dollar were to join the EURO and Australian dollar, it would not be possible to obtain EUR/AUD, wouldn’t it be possible to Exchange Euros with AUD, that’s because at the beginning I write that the US dollar is at the base of the whole forex market even where it appears.
Another important correlation is between the stock market and the u.s. dollar particularly when you buy US shares, the dollar tends to rise and become stronger and that is why when there is risk aversion the Dollar tends to rise because investors prefer to invest in American assets to lower risk and this is reflected automatically in purchase of u.s. dollars.
Another direct correlation is between the interest rates of countries and their currencies. Rising interest rates tend to raise the value of the currency of that country, obviously is contrary to the lowering of interest rates.
For two reasons:
high rates are expanding economy
If a currency is paid a higher rate of interest, the latter will be bought because it’s better to own it for accumulating them interests.
I conclude with a small table that summarizes the percentage correlation between the major currency pairs daily level, on the daily time frame chart.
With this short article I hope I have given some interesting and useful idea to all traders who each day face the arena of forex and so must be in possession of the knowledge needed to make good decisions and correlations from this point of view are very useful because they allow us to infer the movement of various financial instruments in relation to each other.
For now is all, see you in the next lesson!