How the correlation can be used on my Forex investment?
Now we know we can expect certain levels of circulation, in parallel between certain pairs, and we can make better decisions to invest given the information. By creating hedges, risk diversification in profitable positions, and avoiding even positions which are positive correlation causing, naturally, to "cancel" each other.
Here is an example where the risk is diversified using a correlation in a currency pair.
Example 1
Suppose you believe that the dollar is set to rally. The obvious thing would be to go short on the EUR / USD, but that puts her squarely result in the movement of a pair. If you would like to diversify your risk, you can find a partner that has a positive correlation with EUR / USD and split the operation into two pairs. The AUD / USD has a very high - but not perfect - correlation with EUR / USD. You might want to break its position between the EUR / USD and AUD / USD (which has a positive correlation of about .71 (at the time of writing)).
The positive correlation between pairs allows you to benefit from the movement of the dollar, while the lack of perfect correlation reduces the risk of volume in any of the 2 pairs.
Scenario 2
Understanding the correlation allows you to avoid taking positions (due to the high negative correlation) will tend to cancel each other. The pairs of EUR / USD and USD / CHF, are a good example. Couples have a historical correlation coefficient of about - .90. This means that almost always move in opposite directions. Knowing this, an investor will not go long in the two pairs at the same time because the movement of a pair will cancel the movement of the other.
Alternative Strategy.
One possible strategy is the inversion of 2 currency pairs based on the correlation of the reversion. You can track the correlation of 2 currency pairs in time and if it escapes from the norm can reverse direction to grip to fit the correlation again.
For example, if the EUR / USD and USD / CHF has a correlation of - .90 and EUR / USD has high volatility, while the USD / CHF is not moving much, can you go short on EUR / USD and USD / CHF correlation seek to take back as a result of the fall of EUR / USD and USD / CHF to reverse correlation to the historical average. Of course, one must take into account that the correlation is not stagnant and there is no guarantee that will always return.
What is the "correlation" between pairs?
When investing in currency pairs in the Forex market seems to be no end to the external forces that govern the movement of prices. News, politics, interest rates, market direction, and economic conditions are external factors that must be taken into account.
However, there is always the internal force that affects some currency pairs. This force is the correlation.
Correlation is the tendency of some currency pairs that move in tandem with others. The positive correlation means that couples move in the same direction, negative correlation means that move in opposite directions.
The correlation is complex for several reasons and because some currency pairs contain the same currency as your base currency, for example, EUR / USD and USD / CHF. Because the Swiss economy tends to be reflected in Europe generally and in that the USD is on the opposite side of each of these pairs, the movements of a coin, - to some extent - will reflect the other.
Correlation is actually statistical term for measuring the movement between two pairs of tandem pairs. A correlation coefficient of 1.0 means that the pair moves exactly in parallel with each other, a correlation of -1.0 means that the pair moves exactly in the opposite direction.
The numbers between these two extremes showing the relative amount of correlation between a set of Forex pairs. A coefficient of .26 means that couples have a slight positive correlation coefficient of 0 means that the pairs are perfectly independent.
How to Calculate Correlations
The best way to keep track of the direction and strength of the ties of the correlation is computed by yourself. This may seem difficult, but is actually quite simple.
To calculate a simple correlation, just use a spreadsheet like Microsoft Excel. Many software packages (including some free ones) allow you to download daily history of exchange and price to put it into Excel.
In Excel, use the correlation function, which is = CORREL (rank 1, rank 2).
The correlations of one year, six months, three months and one month's readings give the broadest view of the similarities and differences in relation to time. However, you can decide for itself the coins and the time periods analyzed.
Here is the correlation calculation process reviewed step-by-step:
1. Get price data from two currency pairs. For example the EUR / USD and USD / CHF.
2. Make two columns, each labeled with one of these pairs. Then fill the columns with the latest prices that occurred a day for each pair during the period under review.
3. At the bottom of a column, in a vacuum, type = Correl (
4. Highlight all data in a column of prices, you should get a range of cells in the formula box.
5. Add a comma.
6. Repeat steps 3-5 for the other currency
7. Close the formula so that it looks a = Correl (A1: A40, B1: B40)
8. The number that occurs represents the correlation between two currency pairs.
Although the correlations change, no need to update your numbers every day, updating once every week or at least once a month is usually a good idea.
Correlations Change.
It is evident that the correlations change, after making the change of the correlations are equally important to global economic changes, as they are very dynamic and can change even from day to day.
The strong basic correlations may not be consistent with the longest term of the correlation between two currencies. This is the reason why there are six months to observe the correlation.
It is also very important to the proportion of a clearer perspective of the average six-month relationship between the two currency pairs, which tends to be more accurate. The correlation is changed by a variety of reasons. Among the most common are monetary differences, sensitivity to commodity prices, and economic and political factors.
Forex is simple follow the trend and you will rich.
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