US Dollar Guru (Part II)
Suppose you have the data and calculated the currency correlations of the major pairs. The correlation between GBP/USD and EUR/USD is 0.68. This correlation coefficient means both the pairs move in the same direction 68% of the time.
USD/CHF and EUR/USD have a correlation coefficient of -0.975. This is pretty close to (-1). It means both these pairs move in the opposite direction almost all the time. To be precise 97.5% of the time if USD/CHF moves up, the pair EUR/USD will move down!
You have this information. It tells you how much these pairs move in the same or opposite directions. Suppose you trade both the pairs USD/CHF and EUR/USD by going long at the same time. What you will be doing is in fact canceling both the positions.
If you make pips on USD/CHF pair, you will lose pips on EUR/USD pair and the two trades would effectively cancel each other. A savvy currency trader would go long on USD/CHF currency pair. At the same time he/she will go short on EUR/USD currency pair. So he/she will be shorting USD in both the trades. It is a way of diversifying the USD bearish investment.
You can make entry and exit decisions for each trade based on currency correlations. Suppose GBP/USD starts showing volatility. It approaches a resistance level. You plan on going long on a breakout.
However, you notice on the charts that the other three major currency pairs are not showing volatility and moving as much as the GBP/USD. EUR/USD is not showing volatility and moving up on the chart. USD/CHF is not showing much volatility and moving down on the chart. USD/JPY is also not showing much volatility and not moving down on the chart. This means that the volatility in GBP/USD is solely GBP driven. The move is maybe related to some news in the British economy about Bank of England raising or lowering interest rates or some big companies merging.
Now you know that the move in GBP/USD pair is Pound driven and not US Dollar driven. You can take advantage of this information by ignoring the GBP driven move and waiting for a later opportunity that involves simultaneous correlated moves of all the major pairs.
Lets take another example to make things more clear. Suppose you have taken a short position on EUR/USD currency pair. You want to know will the currency pair proceed down towards your profit target. You also want to know can it go against you. If so when to exit the trade with a small loss!
Your EUR/USD has broken the S1 support pivot level and heading towards M1. By looking at the pair EUR/GBP, you find that it has paused at its S1 support pivot level and is showing signs of reversing to the upside.
Knowledge of currency correlations can help you a lot now. It can tell you if EUR/GBP breaks through the S1 level, you are poised for a profitable trade in this type of a situation, However, you should watch the indicators. Exit before taking a big loss if EUR/GBP reverses and heads back to the upside. You might consider trading a basket of all the major currencies as you mature in forex trading. - 23159
USD/CHF and EUR/USD have a correlation coefficient of -0.975. This is pretty close to (-1). It means both these pairs move in the opposite direction almost all the time. To be precise 97.5% of the time if USD/CHF moves up, the pair EUR/USD will move down!
You have this information. It tells you how much these pairs move in the same or opposite directions. Suppose you trade both the pairs USD/CHF and EUR/USD by going long at the same time. What you will be doing is in fact canceling both the positions.
If you make pips on USD/CHF pair, you will lose pips on EUR/USD pair and the two trades would effectively cancel each other. A savvy currency trader would go long on USD/CHF currency pair. At the same time he/she will go short on EUR/USD currency pair. So he/she will be shorting USD in both the trades. It is a way of diversifying the USD bearish investment.
You can make entry and exit decisions for each trade based on currency correlations. Suppose GBP/USD starts showing volatility. It approaches a resistance level. You plan on going long on a breakout.
However, you notice on the charts that the other three major currency pairs are not showing volatility and moving as much as the GBP/USD. EUR/USD is not showing volatility and moving up on the chart. USD/CHF is not showing much volatility and moving down on the chart. USD/JPY is also not showing much volatility and not moving down on the chart. This means that the volatility in GBP/USD is solely GBP driven. The move is maybe related to some news in the British economy about Bank of England raising or lowering interest rates or some big companies merging.
Now you know that the move in GBP/USD pair is Pound driven and not US Dollar driven. You can take advantage of this information by ignoring the GBP driven move and waiting for a later opportunity that involves simultaneous correlated moves of all the major pairs.
Lets take another example to make things more clear. Suppose you have taken a short position on EUR/USD currency pair. You want to know will the currency pair proceed down towards your profit target. You also want to know can it go against you. If so when to exit the trade with a small loss!
Your EUR/USD has broken the S1 support pivot level and heading towards M1. By looking at the pair EUR/GBP, you find that it has paused at its S1 support pivot level and is showing signs of reversing to the upside.
Knowledge of currency correlations can help you a lot now. It can tell you if EUR/GBP breaks through the S1 level, you are poised for a profitable trade in this type of a situation, However, you should watch the indicators. Exit before taking a big loss if EUR/GBP reverses and heads back to the upside. You might consider trading a basket of all the major currencies as you mature in forex trading. - 23159
About the Author:
Mr. Ahmad Hassam is a Harvard University Graduate. He is interested in day trading stocks and currencies. Know These Forex Broker Games. Learn Forex Trading!
posted by X - Men @ 2:09 AM
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