What is the correlation of currency pairs?

Traders use different types of analysis, usually technical analysis and fundamental analysis, to increase trading efficiency in the currency market. Professional traders also use the correlation of currencies and/or other assets to increase profitability and hedge risks of open positions. Below we will look at what correlation is, its types, the correlated currencies, and how you can use it.

Correlation - the relationship between two different currency pairs, against which they move either in the same direction, and this is called positive correlation, or in the opposite direction, in which case the correlation is called negative.

Essentially, correlation is the repetition of one instrument's movement of another, i.e. the ability to move synchronously in the same direction. Different instruments can be correlated - currency pairs, stock indices, commodity assets; currencies can follow indices, commodity assets, and/or other currencies. For example, if the economy of a country depends on the oil market then its currency rate can also depend on the movement of oil futures, i.e. if oil goes up in price the currency of the country goes up, and vice versa if oil goes down the currency rate goes down.

What is the correlation coefficient?

The correlation coefficient, which is calculated using Pearson's formula, is used to determine the degree of correlation:

Here one chooses some set of price values of assets X and Y, selects their average values on it, sums the product of the deviations of each value of the set from its average, and divides them by the product of the standard deviation. Of course, these days, appropriate programs do all the calculations.

Values below -0.70 and above +0.70 are considered strong indicators, and between - weak, i.e. instruments whose correlation in the negative range from -0.70 move relatively the same, but in different directions, and from +0.70 - move relatively the same and in the same direction.

In the next article, we will look at some other useful aspects of this topic.

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