#1 GLOBAL FOREX PRICE ACTION EBOOK

PRICE ACTION
CORRELATION
Discover the benefits of trading smart

BY AIRFOREXONE @AIRFOREXONE
CORRELATION ANALYSIS

Trading Foreign Exchange (Forex) requires great knowledge of technical analysis

and fundamental analysis. Although most traders tend to focus on one of the
approaches mentioned above, today, more and more attention is being paid to
proper trading psychology and risk management. This is where currency correlation
comes into play.

WHAT IS CORRELATION?

In the financial world, correlation is a statistical measure of how two instruments

move in relation to each other.

The financial market is a volatile market and most of the time the currency pairs,
cryptos, commodities, stocks, or indices are impacted by the fundamental and
economic factors which cause them to move in the same, opposite, or random
direction, over some time.

The correlation action is quite visible on the price action chart of the intending
financial instruments which when taking into consideration can help traders to
maintain proper risk management, improve your technical analysis, and helps you
avoid overtrading.

TYPE OF CORRELATION

The range of the correlation coefficient is between -1 and +1.

1. Positively Correlated (0.01 to 1 or 1% to 100%): A currency pair is

considered to be positively correlated with another if their values move in
the same direction at the same time. (One goes up- the other to)

XAUUSD-XAUGD daily time frame

@AIRFOREXONE
2. Negatively Correlated (-100% to -0.1% or -1 to -0.01): A currency pair is
considered to be negatively correlated with another if their values move in
the opposite direction at the same time ( One goes up – One goes down)

DXY-EURUSD daily time frame

3. No Correlation (0): The movements between two currency pairs are said to
have ZERO or NO correlation if they are completely independent and
random from each other.

@AIRFOREXONE
CORRELATIONS DO CHANGE

It is clear then that correlations do change, which makes following the shift in
correlations even more important. Sentiment and global economic factors are
very dynamic and can even change on a daily basis. Strong correlations today
might not be in line with the longer-term correlation between two currency pairs.
That is why taking a look at the six-month trailing correlation is also very
important. This provides a clearer perspective on the average six-month
relationship between the two currency pairs, which tends to be more accurate.
Correlations change for a variety of reasons, the most common of which include
diverging monetary policies, a certain currency pair's sensitivity to commodity
prices, as well as unique economic and political factors.

How to know when correlation is strong?

My fx book has everything about forex correlation strength, we highly advise to

take a look at least one time per week .

https://www.myfxbook.com/es/forex-market/correlation

CORRELATED PAIRS ON AIRFOREX ONE WATCHLISTS

NEGATIVELY CORRELATED ( ONE GOES UP – ONE GOES DOWN)

i. EURNZD - NZDCHF

ii. EURAUD – AUDCHF

iii. EURUSD - USDNOK

iv. DXY (DOLLAR INDEX) - EURUSD

vi. EURCAD – CADCHF

vii. DXY-GOLD(XAUUSD)

iv. USDJPY-GOLD(XAUUSD)

vi.DXY-EURUSD

POSITIVELY CORRELATED

i. XAUUSD (GOLD) – XAGUSD (SILVER)

ii. AUDUSD – AUDCHF

iii. AUDJPY – NZDJPY

@AIRFOREXONE
iv. AUDUSD – NZDUSD

vi. EURUSD-GBPUSD

HOW CURRENCY CORRELATION CAN HELP YOU BECOME A SMARTER

TRADER

1. HELP YOU TAKE ADVANTAGE OF SLOW MOVE IN PRICE ACTION.

Currency correlation can help you take advantage of the slow movement in the
price action of the correlated counterpart. Sometimes one of the correlated pairs
(positive or negative) price action might be lagging or slow to react which in turn
can give traders the advantage to enter a trade with a tight stop loss rather than
position in a trade which price action is already extended and didn’t offer a good
risk-reward.

Recent Example of this is EURUSD & USDNOK negatively correlated pairs:

USDNOK, H4 CHART THE SAME DATE SAME HOURS

EURUSD, H4 CHART

@AIRFOREXONE
In the EURUSD and USDNOK charts above, the prices make a related impulse
and corrective structure pattern, however, the EURUSD is moving in a faster pace
than its correlated counterpart which causes it to make a strong impulse while
USDNOK is still trading playing in the resistance .

Knowing that USDNOK mostly reacted in the same way with EURUSD but
negatively, this allowed us to take a position in USDNOK earlier knowing that a
strong bearish breakout is pending. This helped us to tighten the stop loss and
increase our risk to reward ratio.

2. HELP YOU TO FILTER OUT LOW-QUALITY SETUP

The study or understanding of correlation analysis can help you to confirm your
technical analysis by having the choice to select/trade the pair with clear price
action out of the correlated instruments on your list. This will increase your
confidence in your analysis and shift the odds of winning in your favour.

Recent Example of this is NZDCHF & EURNZD negatively correlated pairs:

NZDCHF DAILY CHART

EURNZD DAILY CHART

@AIRFOREXONE
As you can see from the charts above, the NZDCHF is approaching a resistance
while EURNZD is approaching a support level. Two days before the strong move
“NZD high impact fundamentals news”, NZDCHF didn’t print any nameable price
action or bearish signal at resistance level while the EURNZD printed a strong pin
bar/ bullish rejection candle at the support level followed by another bullish candle.
The current situation helps us to make a better decision by going for “EURNZD”
setup with more confirmation and price action signal to work with because it has a
high probability of working out than the NZDCHF with weak price actions.

See what happened one day later in NZDCHF

3. HELP YOU TO MAKE RESPONSIBLE RISK MANAGEMENT DECISIONS

Sound risk management is essential when making trading decisions in order to

lower the adverse effects if you suffer a loss. Understanding of currency correlation
can help you become a smarter trader and make more responsible risk
management decisions.

CORRELATION TRADING - RISK MANAGEMENT TIPS

(a) Don’t enter a trade on correlated pairs at the same time

For example, if you enter a short position on NZDCHF and long trade on EURNZD
at the same time, you are doubling up your risk. It’s just like you have two trades
open on either of the pairs because they usually have a negative correlation, and
you risk the chance of getting stopped out at the same time if the trades didn’t work
out. Although it might be rewarding if the price moves in the direction that you
speculate, but it can cause more damage to your trading account and psychology
in the long run. Althought if strenght negative coorelation sometimes can be fast an
then slow.

The same goes for trading AUDJPY & NZDJPY at the same time. You might
believe that you’re spreading or diversifying your risk by trading in different pairs,
but many pairs tend to move in the same direction. So instead of reducing risk, you
are magnifying your risk! Unknowingly, you are actually exposing yourself to MORE
risk.

Best way to handle this situation is to split your entire risk into two and use half
your original risk on each pair; this way if the trade didn’t work out you would lose
just your original risk amount.

(b) Avoid positions that cancel each other out ( the most important part)

If you see two currency pairs that are negatively correlated or move in opposite
directions nearly all of the time, you should realize that holding long/short positions
in both of those currencies at the same time mitigates any potential gain that could
be had.
For example: If you short EURUSD and USD INDEX “DXY” at the same time there
is a high probability that you will get stopped out on one of the position. To avoid
this, always go for one

EURUSD DAILY 1 HOUR CHART LONG

@AIRFOREXONE
DXY DAILY ONE HOUR CHART LONG ON THE SAME DAY AS EURUSD

In the charts above, long EURUSD & DXY at the same time could has cause you a
loss on DXY because both pairs are negatively correlated and most of the time will
move in opposite direction.

FINAL NOTE

Be careful! Currency correlation change and they frequently change especially on

the shorter time frame. The currency correlations between currency pairs can be
strong or weak for days, weeks, months, or even years, they do eventually change
and can change when you least expect it. The strong currency correlations you see
this month may be totally different next month.

@AIRFOREXONE
Because of the constant sentiment shifts of the currency market, make sure you’re
aware of the current currency correlations.

Telegram channel https://t.me/airforexone

Instagram @airforexone

Javier-Nelson from Airforexone

@AIRFOREXONE