Correlation is a statistical measure of the relationship between any two items. The value of correlation varies from -1 to +1. In our context, a correlation of +1 implies that the two currency pairs will move in the same direction 100% of the time. A correlation of -1 implies the two currency pairs will move in the opposite direction 100% of the time. If the movement of one pair doesn't tell anything about the movement of the other pair then there is zero correlation between these pairs.

Expert traders who have a portfolio under management try to get a comprehensive picture of the market volatility on their portfolio. Since a currency pair price is relative to other currency pairs there is always some relationship between them. Correlation is a good measure of this relation. Once you are aware of these correlations and how they change, you can use them control your overall portfolio's exposure.

All correlations are as follows:

1. Weak: the absolute value of the correlation coefficient is between -0.3 to +0.3.

2. Medium: the absolute value of the coefficient is greater than 0.3 but less than 0.5.

3. Strong: the absolute value of the coefficient is greater than 0.5 but less than 0.8.

4. High: the absolute value of the correlation coefficient is equal to or greater than 0.8.

It's easy to understand correlation if you trade in derived pairs such as GBP/JPY. Since this pair is derived from GBP/USD and USD/JPY pairs, it is likely, that GBP/JPY is correlated to one or both of the parent pairs.

Note: Trading multiple currency pairs is not necessarily diversification as in stocks. Though you are hedging risks by investing in two economies, a positive correlation can in fact increase your risk profile.

- What is currency correlation?
- Risk exposure
- Caution with currency correlation
- Currency correlation using Excel

Table of contents

1. Currency correlations

- What is currency correlation?
- Risk exposure
- Caution with currency correlation
- Currency Correlation Using Excel

2. Equities to trade forex

3. U.S Dollar Index

4. Market sentiment analysis

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