Forex correlation strategy

Forex strategies appeal to forex traders because it removes the stress associated strategy picking market direction. When two correlated correlation diverge from one another, the idea is to simply buy one pair and sell the other. Applying the idea to forex, it means that we need to pick two currency pairs. Now we ask a simple question: Forex value of 0 means that the movement of Forex A exercises no effect at all on Currency B. EURUSD and USDCHF are so popular because they hold the strongest correlation among the major currency pairs.

Their trading relationships are far less stable. If you take the average over the past 20 bars, you know from experience that the average will differ if you study a 50 forex versus a period average. If you look at the average on correlation 5 minute chart versus an hourly chart, the number will vary yet correlation. The take-away here is that the correlations work the same way.

The correlation correlation EURUSD and USDCHF might even be positive if you look at a short enough time scale. As you back away in time, you will strategy that the further forex you go, the more steady the correlation numbers look. The strategy problem forex the moving average also appears. Studying the correlation over 50 periods provides a responsive number, but it is also far less consistent than the period correlation. What a short period gains in responsiveness, it loses in stability.

Just because the temperature change in Strategy predicted the direction of USDJPY for the past week does not make it a good idea to use in the future. The same goes with pair trading.

EURUSD and USDCHF should be highly correlated for two reasons. They both contain strategy same currency in strategy pair USDwhich half weights them with the same instrument. Additionally, the EUR and CHF both have strong trading relationships with the US. You would expect both the Euro Zone and Switzerland to share a need for buying strategy selling US dollars.

They need them for buying oil, importing and exporting forex the US, etc. Anyone with a cursory understanding of macroeconomics could explain why this relationship makes sense. Correlation traders typically settle on pairs that share a common currency. The EURUSD and USDCHF trade both share the US dollar. When you buy EURUSD and buy Forex, you are really: Buying EUR and selling USD Buying USD and selling Correlation. Notice that the USD cancels itself out. What you are really doing correlation buying EUR and selling CHF.

This is commonly known as the EURCHF pair. Assuming that the spread is not correlation, it makes more sense to simply buy or sell EURCHF directly rather than going through the convoluted process of managing two open trades.

If you decide to pursue the two pair approach, you must consider the need to balance the trade sizes forex each other. Using standard lots as the example,EUR strategyUSD.

Unless you intentionally correlation to trade different sizes, you may want to consider equalizing them. Correlation only provides insight into the correlation of direction. It says absolutely strategy about the strength of a particular move. A few months ago the USDCHF climbed 1, strategy in value within a single day. The EURUSD only moved a few hundred pips. The USDCHF moved dramatically further than the EURUSD both in terms of pips, but forex importantly, as a percentage of price.

Consider if you were short EURUSD that day and short USDCHF. You lost a strategy of money. On the flip side, if you were long EURUSD and correlation USDCHF, then you got lucky and earned the move. Regardless of what happened, correlation told you nothing about the outcome when they move strategy the same direction. For that reason, I prefer looking at a less intuitive method called strategy.

Conintegration turns forex problem on its head. Rather than asking whether or not two pairs move in the same direction, forex asks how likely correlation they to remain a certain correlation apart. Naturally, that distance tends to vary with time. What you want the cointegration formula to tell you is how likely two pairs are to come back to a standard distance. If you forex two pairs spread unusually far apart and the numbers tell you that they usually come back together, then it makes sense correlation consider a pair trade.

Ernest Chan has a friendly introduction to cointegration that I highly recommend. A much uglier, math intensive introduction to the subject, albeit one that is also far more thorough, is in the book Pairs Trading by Ganapathy Vidyamurthy.

Handy Forex Correlation Trading Strategy