Updated: Aug 7, 2022
Currency Correlations in Forex Trading
Forex correlations or currency correlations is a way for traders to identify whether one currency pair/ forex pair will move similarly to another currency pair.
A positive correlation is represented by two currency pairs going up at the same time or down at the same time.
However, if one currency pair moves opposite to the other i.e. one goes up and the other goes down this is known as a negative correlation.
Currency correlations are important to monitor and understand not only when analysing price but also when analysing any other commodity, stocks or instrument. In this article, we will look at how forex currency correlations is determined, how to calculate it yourself using excel and how it affects trades.
What do correlated forex pairs mean?
Currency pairs are correlated when they move dependent of each other. This can happen when the currencies in each pair are the same or include the same economies.
For example, EUR/USD and GBP/USD both contain USD as a common factor. On top of this the Eurozone and Great Britain are closely tied economies trading together. These factors are a core reason of a correlated forex pair.
This means you'll tend to see most USD currency pairs move in the same direction if the USD is on the quote side of the exchange rate i.e. AUD/USD and NZD/USD will also be a correlated forex pair.
You'll tend to see however that some correlated forex pairs will have a weaker or stronger relationship. This is because all these currencies are separate economies, they all sell different things and affect the exchange rates in different ways!
What do non-correlated forex pairs mean?
Currency pairs that are non-correlated move independent of each other. This generally happens when the currencies in two separate pairs are completely different or are from different economies respectively.
For example, EUR/USD and GBP/NZD. These two currency pairs are non-correlated as they don't include any common currency between them and it's 4 separate economies (Eurozone, US, UK and New Zealand). This means there's a good chance that if one grows there's no correlation for the other to grow too.
Trading Currency Correlations
Forex traders will use currency correlations to either hedge their trades, increase their risk or use it for creating value via commodity correlations. There are various ways to trade currency correlations.
Traders will use a currency correlation to potentially increase their profits. For example, since GBP/USD and EUR/USD are positively correlated a trader might place a long trade on both to utilise the relationship.
Potentially increase returns over more currency pairs
Taking on more risk
On the other hand, traders may be more risk averse and opt to use currency correlations to reduce risk. For example, instead of placing a max position size on EUR/USD the trade may split 50% of the position size on EUR/USD and the other 50% on GBP/USD.
Potentially reduce risk by splitting across more economies.
Transaction costs are higher
Alternatively, a trader may use correlation to assess a value of a currency pair. For example CAD pairs are highly correlated to Crude oil prices (WTI).
The trader may analyse that if WTI prices rise there's an expectation that CAD prices may also rise. Therefore, not directly trading the correlation but using the correlation within their analysis.
Which Forex Pairs are Most Correlated?
In the correlation table above we've highlighted 5 of the major currency pairs to get the top 5 forex correlation pairs in a view.
Top 5 currency correlation pairs
AUD/USD vs NZD/USD = 87% correlated
EUR/USD vs GBP/USD = 89% correlated
EUR/USD vs USD/CHF = -91% correlated
GBP/USD vs USD/CAD = -88% correlated
GBP/USD vs USD/CHF = -93% correlated
Forex Correlation Cheat Sheet
What we can see in the correlation table is that there are positive and negative correlations.
If we look at the top row of AUDUSD we can see it is 56% correlated to EURUSD at the time of writing this post but also it has a 87% correlation to NZDUSD!
You might notice however, there are negative correlations in there too.
This generally happens when the quote currency is on the base currency between the analysed instruments. For example. AUD/USD vs USD/JPY correlation, USD is on the quote (right hand side) for AUD/USD but it's on the left (base currency) for USD/JPY. This generally creates an negative correlation as it's essentially flipped upside down!
Commodity Currency Correlation
Commodities also have correlations between currency pairs and are used widely when forex trading. It's a great way of assessing the overall risk sentiment of investors/ traders.
For example, XAU/USD (Gold) vs SPY (US stock market) shows a negative correlation. This relationship shows the risk appetite of investors.
If the prices of Gold rise stocks tend to fall, this would be a risk off sentiment for investors, meaning, investors would rather hold a safer less volatile asset over riskier volatile assets.
On the flip side, if Gold prices fall stocks tend to rise indicating the opposite a risk on environment. Investors are willing to take on more risk, they're optimistic about future gains and move their money from safer assets like gold to stocks to make more money.
These commodity correlations apply to forex too as there are risk currencies and safe currencies.
Safer currencies are the likes of: USD,JPY and CHF.
Risk currencies could be exotics like: MXN, ZAR and potentially even NZD/AUD/CAD.
Gauging the risk sentiment of the market is important for forex traders to not be on the wrong side of trades during the risk on/off environments.
How to Calculate Currency Correlations - Excel Template
Calculating the correlation mathematically is super easy with the use of excel and spreadsheets. In this part of the article we'll cover our excel template on working out the correlation of data you paste in. This can be between any forex pair, commodity, bond or stock.
Remember the markets are interlinked so it's always useful analysing factors outside of currencies to generate your ideas.
Step 1. Copy and paste price data into Data set 1 & 2
In step 1 you can see in the calculator the only data you need to find is the price data of the currency pair or instrument you want to analyse.
In this example we've compared EUR/USD and AUD/USD against each other.
To do that we've pasted in historical price data of EUR/USD into the red section 1 on the left, then pasted in historical price data of AUD/USD into the right hand side section 2.
The formula column will automatically calculate how much the price has increased or decreased.
Step 2. Analyse the correlation
The next step is changing the sheet to our automatic chart maker and correlation.
This page is all done for you so don't worry about making the chart yourself or calculating the mathematical correlation value.
It's all calculated based on the previous steps; the data pasted in beforehand.
Once you've figured out whether there's a positive correlation or a negative correlation you know which way trades will be if you wanted to trade a correlated pair.
Alternatively, you can use the calculator in a systematic plan to calculate the value. This is what the beginner forex course learning portal covers.
And here's a tip from our CEO:
To increase your success rate, try to make sure their is a very low correlation between all of your trades. This means each individual trade has it's own merit to succeed, without exposing risk too much risk to one idea. - Marcus Raiyat, Founder & CEO of Logikfx
Now you should know all you about currency correlations and forex correlations, how they're utilised by traders and how you can do the same using the calculator above to generate great ideas.