Currency pairs and correlation

Currencies are mainly based on the three-letter code. There are at least one hundred and seventy different currencies, and the USD (U.S. Dollars) has the most majority in Forex trading. Next will be the European Union, Japanese Yen, Canadian Dollar, British Pound, and New Zealand Dollar.

Forex trading is based on two currencies being exchanged. So, the combination of two different currencies works as a trading part. EUR (European Union)/USD (U.S. Dollar) is one of the major combinations of currencies.

If you consider EUR/USD, the EUR is the base currency, and the USD is the quote currency. Therefore, the exchange rate depends on how much of the quote currency is needed to purchase one unit of the base currency. For example, if the exchange rate is 0.57, you need 0.57 USD to buy 1 EUR. Therefore, if the exchange value is high, the quote currency value has fallen, and if the exchange rate is low, the quote currency value has risen.

The correlation is the relation between the two currencies. The currency pair has to be associated with Forex trading, and the correlation coefficient defines this relationship. Obviously, the currencies are paired in Forex, so this represents how the exchange rate will perform.

The correlation coefficient is between -1 to +1. If the correlation is positive, the currencies are moving together, and if it's negative, they are moving in the opposite direction. If the correlation coefficient is zero, then the currency pair is at an arbitrary point.

Calculating correlation

To calculate the correlation between currency pairs, you can go for Microsoft spreadsheets. This is the best way to develop your strategies. First, choose a currency pair and put them on your spreadsheet. Then fill the columns with their daily prices. The prices are readily available on the internet. And with the CORREL in a spreadsheet, you will get the correlation between the pair. You can update your data every other day.

Correlation changes quickly. For example, suppose in a particular month, EUR/USD correlation is 0.74, and in three months, the correlation is 0.63. This means that the correlation was weaker in three months, but the correlation is still positive.

The correlation between the currency pairs is never stable, and the global economic factors are directly connected to them. So if the correlation is strong today, it doesn't mean it'll remain firm in the long run. And this is why a period of six months is suggested in defining correlation.

Trading with the pairs:

A trader can sell the pair with a positive correlation and buy the couple with a negative correlation. The main thing is to purchase a pair that has a higher correlation, thus ensuring that they move together. The long history of high correlation will result in profit.

You can always control the loss with stop-loss. But it is not entirely possible to gain profit with the trade even if the pair moves upwards. So with any correlation strategy, the position is the key to minimize loss.

To sum up...

The currency pairs are the primary source of Forex trade, and to get a minimum profit, first, you need to understand the relation between the currencies.