Which Currency Pairs are Correlated?

In the world of finance, the correlation represents the relationship between the assets. Let’s take a look at what the correlation is in Forex trading, which currency pairs are correlated, and how to take advantage of it in Forex trading.

Correlation coefficient range

The correlation between the currency pairs can be positive and negative, and the correlation coefficient measures it.

But how does one determine which currency pairs are correlated, and to what extent? The correlation coefficient between the two currencies can go from -1 to +1. It can also sometimes be expressed as -100 to +100. When the correlation is +1, that means that the two pairs are going in the same direction 100% of the time. On the other hand, if the correlation coefficient is -1, the two pairs are going in two opposite directions all the time.

The coefficient of 0 means that pairs don’t have any correlation between them. The span of -1 to +1 represents wiggle room for degrees of correlation. If it is above 70 percent in a positive or negative direction we can say the currencies don’t move the same way. If they are below 60 then there is no correlation.

Commodities related to currency pairs

Currency pairs correlate with each other. But they can also correlate with commodities. That’s because some commodities have an important place in the economy in some countries. For example, Australia is number 2 in the world ranking of gold producing countries. So this commodity has a great influence on the country’s economy, and the AUD / USD pair, therefore, correlates with the evolution of the gold price.

Regarding oil, Canada is a country that has significant oil production. Suddenly, the price of oil will influence the USD / CAD pair. You should also be aware that correlation coefficients are not static numbers at all. On the contrary, it’s something very, very dynamic.

How to implement the correlation in Forex trade

If trading particular currency pairs based on correlation is something that interests you, let’s see how to do it.

1) The two pairs are in correlation:

If two currency pairs are correlated, that means they are moving at the same time in the same direction. But you have no strategic interest in taking a position on both pairs at the same time. So, you could wait and take new positions on only one of the two currency pairs. It’s called pyramiding and, at the strategic level, it’s beneficial.

2) The two pairs are not in correlation:

This can be an excellent opportunity if you want to invest your money in each of the two pairs.

On the other hand, always be careful and wait for the right time to do so, for example, when your first position is under hedging.

Strongest Positive Correlation Currency Pairs

Let’s see which currency pairs are correlated in a positive direction. Those are usually currencies of tightly linked economies. Take, for example, the economy of the UK, the Japanese economy, and the US economy. The combination of these currencies results in the strongest correlated currency trading pairs.

Or let’s focus on EUR/USD GBP/USD currency pairs positive correlation. The correlation of these pairs goes above 80 percent, meaning that an upward or downward trend of one pair goes in parallel with the other. The variations are occurring only 10 percent of the time. Sudden deviations are always possible due to many factors, such as political or economic events. In general, these pairs tend to go in the same direction.

The strong correlation specifically for EUR/USD and GBP/USD comes from the fact that the base or money currency is the same –USD. Every change regarding the strength of the US economy and consequently, the US currency, will reflect on the particular trading currency. For instance, in the case of unemployment rates rising, the US dollar falls, and the EUR/USD currency pair goes up. The same means for the GBP/USD.

Among the other pairs that go in the same direction, the strongest correlation has AUD/USD, NZD/USD, EUR/JPY, AUD/JPY, and NZD/JPY. The patterns and the amplitude of their movements can largely differ.

Strongest Negatively Correlated Currency Pairs

Among the pairs that tend to move in diametrically opposite directions are USD/CHF, USD/JPY, USD/CAD, USD/NOK, USD/SEK, USD/DKK, USD/SGD.

Let’s take, for example, the negative correlation between EUR/USD and USD/CHF. When the first pair goes up, the other will trend down and vice versa.

The reason behind this strong negative correlation lies in the fact that these pairs have the USD  in common. But the opposite will happen compared to the above-explained positive correlation example. In an economic crises, people search for safe havens such as the USD. The US dollar becomes stronger, pulling EUR/USD currency pairs down and lifting the USD/CHF currency pair. Furthermore, the euro and the swiss grow strong economic relationships and are big trading partners who reflect on the currency pair trends.