Leveraging Correlations Between Currency Pairs for Smarter Trading  

Forex is a highly volatile market in which traders ponder over various factors to make the wisest decisions. A mostly forgotten yet quite powerful stratagem is manipulating the correlations between currency pairs. Being familiar with the way two different pairs move relative to the other enables traders to pull off better trades, shields them from risks, and asserts profits. Whether you are a sole trader or working through a prop firm, a platform like cTrader will provide you with an essential requirement to use this knowledge as a base for smarter trading.  

What Are Currency Pair Correlations?  

A currency pair in the forex market does not simply do its own thing. The ups and downs of their prices are often intertwined due to interrelatedness with the macroeconomic situation, market sentiments, and economic connections that occur between them. This is the so-called currency pair correlation.  

Correlations are measured on a scale from -1 to +1:  

– +1 (Perfect Positive Correlation) – Two currency pairs move in the same direction almost exactly.  

– 0 (No Correlation) – There is no predetermined, established relationship between the two pairs.  

– -1 (Perfect Negative Correlation) – Two currency pairs move in the exact opposite directions.  

An instance is that along with USD/JPY and USD/CHF, EUR/USD and GBP/USD are more likely to have a high correlation, as these pairs are usually dragged (up or down) by the strong or weak US dollar. By contrast, EUR/USD and USD/CHF usually exhibit a negative correlation because the Swiss franc moves in the opposite direction to the euro.  

How Currency Correlations Impact Trading Decisions  

One of the main factors for the traders to make correct trading decisions is the comprehension of the correlations between different assets.  

 1. Risk Management and Diversification  

Executing similar trades in two highly correlated pairs simultaneously comes with a risk of exposing the trading account to a double amount of risk. In case both trades move against you, the loss will be accentuated. On the other hand, participating in the trade of negatively correlated pairs might be of great help to set a shield against the possible losses.  

Example:  

– If you trade long on EUR/USD and overnight forward on USD/CHF, you play the strengthening of the euro against the dollar. Since these pairs are negatively correlated, you can earn some profit in a trade to offset the losses that you might have in another.  

 2. Avoiding Overleveraging in Prop Firms  

A lot of prop firms have strict risk boundaries, and entering several positions in highly correlated pairs unintentionally breaches those limits. For example, buying EUR/USD, selling GBP/USD, and buying AUD/USD simultaneously, will increase the dependence on movements of USD, and your portfolio will be very fragile if something surprising happens.  

 3. Improving Entry and Exit Points  

In case a primary trading pair does not validate the alert, a correlated pair might make it possible to get valid confirmation.  

Example:  

– On the other hand, if EUR/USD breaks through a key resistance level, while GBP/USD has not confirmed a similar move, the trade may be less accurate, but nowadays it is easy to call off the two, or to take the trade if the two confirm the direction of the move.  

 4. Using Correlation for Confirmation Signals in cTrader  

In case you are using cTrader for technical analysis, looking at the correlated pairs may help you see if your trades are correct by following the price action on multiple markets. For instance, if you will be buying the Australian Dollar on a long trade, you can look at another pair during the same setup like NZD/USD for more accuracy.  

How to Use Correlation in Your Trading Strategy  

 1. Identify Correlations Using Tools  

Now every trade platform offers the ability to show the correlation you want. For example, you can find all the necessary platforms cTrader provides. Websites like Myfxbook or custom scripts in MetaTrader are offering traders the analysis of correlation as well.  

 2. Adjust Position Sizing Based on Correlation  

In case one should manage two correlated pairs and still do so, threatening the account as a whole, it is advisable that the trader should decrease position size. A good instance is the temptation that appears to be very high: to trade big positions in both EUR/USD as well as GBP/USD. Instead, think about your risk equally during both the trades.  

 3. Hedge Your Trades Smartly  

The trade set-up involves holding either of the two complementary trades and never both short to each other. Another instance is when the person is crazy to buy the EUR but they are afraid the expected dollar strength might ruin their deal. Hence, they buy the USD/CHF to save their position.

 4. Use Correlation in News Trading  

In times of major news, the currencies between the euro and the US dollar and the British pound and the US dollar usually show stronger positive correlations than on other days. For instance, in the case of the central banks’ decisions that weaken the US dollar, EUR/USD and GBP/USD, which are positively correlated, will move up way. Conversely, USD/CHF and USD/JPY, are the negatively correlated pairs that may slump if the US dollar goes down.  

 5. Optimize Prop Firm Challenges  

When you take part in a prop firm challenge with a piece of a larger trading account, the concept of this challenge is to really avoid as much risk as possible, especially if it is not really necessary. Being able to make sense of the correlation concept is allowing the trader to face the drawdowns while preventing and it also increases the success chances in the processes.  

Conclusion  

Currency pair correlation, as a technique of high forex trading skills, introduces various risk management techniques, discipline, and profit. So, whether you are cTrader’s user or the staff trader, hence, the deep knowledge of these relationships will definitely set you apart from the others. As a result of monitoring correlations, making smart trade sizes alterations, and, last but not least, supporting the diversification of positions will lead to the trading stage where these traders will be injected with more confidence and hence better and faster in terms of efficiency.