WEBVTT 0 00:08.630 --> 00:17.800 What is correlation? Correlation is a statistical measure of how two variables are related. In Forex trading, 1 00:17.800 --> 00:22.880 correlation is a measure of how two currency pairs are related. 2 00:23.180 --> 00:30.020 I'm sure that sometimes you have noticed that two currency pairs seem to go in the same direction. 3 00:30.020 --> 00:33.210 This is called positive correlation. 4 00:33.440 --> 00:37.640 Sometimes currency pairs seem to go in the opposite direction. 5 00:37.670 --> 00:40.760 This is called negative correlation. 6 00:41.030 --> 00:47.870 The correlation coefficient ranges between -1 and +1. With +1, 7 00:47.870 --> 00:51.230 we have a perfect positive correlation. 8 00:51.230 --> 00:58.790 This means that the currency pairs move exactly in the same direction all the time. With -1, 9 00:58.790 --> 01:06.280 we have a perfect negative correlation, which means that the currency pairs move in the opposite direction 10 01:06.320 --> 01:08.240 all the time. 11 01:08.240 --> 01:16.310 Let's have an example. Dollar against Swiss Franc and Dollar against Canadian Dollar have a correlation 12 01:16.310 --> 01:22.010 coefficient of 0.31. What can we say about it? 13 01:22.070 --> 01:26.020 It is a positive correlation but not too strong. 14 01:26.180 --> 01:33.210 So these two currency purchases sometimes have the same movements but it doesn't happen often. 15 01:33.590 --> 01:36.770 To understand better how correlation works. 16 01:36.770 --> 01:42.270 It is important to analyze single currencies and not in a pair. 17 01:42.350 --> 01:51.540 So we have pound, United States dollar and euro. The strongest one, at the moment, is the pound. 18 01:51.560 --> 01:58.740 The second one is the United States dollar and last one is euro, which is very weak at the moment. 19 01:59.150 --> 02:07.670 What if we open a long position on pound-dollar and a short position on euro-dollar? Many traders 20 02:07.670 --> 02:14.920 will tell you that it doesn't make sense because these two currency pairs have a strong correlation. 21 02:14.960 --> 02:19.770 It is hard that you will have a profit from both of your positions. 22 02:20.060 --> 02:26.240 If you have a look at the list, the pound is gaining against the United States dollar, because it 23 02:26.240 --> 02:27.800 is stronger. 24 02:27.950 --> 02:34.400 The United States dollar is weaker than the pound but it is stronger than the euro. 25 02:34.610 --> 02:41.780 A long position on pound-dollar and a short position on euro-dollar would be both profitable 26 02:41.810 --> 02:43.420 in this case. 27 02:43.640 --> 02:50.750 Of course the best option for you in this scenario would be a long position on pound-euro or a 28 02:50.750 --> 02:53.870 short position on euro-pound, if you prefer. 29 02:53.870 --> 02:59.600 It is exactly the same. If we check a correlation chart, like this one 30 02:59.610 --> 03:06.780 on OANDA, we can see that there is a strong correlation between euro-dollar and pound-dollar. 31 03:07.480 --> 03:14.690 One hour and one day don't count for now, because I'm recording this video on a Sunday so they are 0 32 03:14.750 --> 03:15.680 and 1, 33 03:15.740 --> 03:21.670 but, if you check all the others, you can see that there is a strong correlation between them. 34 03:21.950 --> 03:25.870 This can be explained, once again, looking at the single currencies, 35 03:25.880 --> 03:33.680 instead of considering them in a pair. Euro-dollar and pound-dollar have both the dollar in common. 36 03:33.680 --> 03:40.640 This means that if the dollar is very weak, probably Euro and Pound will both gain against the dollar. 37 03:41.090 --> 03:47.160 If the dollar is very strong, Euro and Pound will both lose against the dollar. 38 03:47.420 --> 03:55.230 This leads us to my first advice: avoid to trade correlated currency pairs in days with important 39 03:55.230 --> 03:55.920 news, 40 03:56.000 --> 04:01.910 if the news is about the currency that is in common in both of your potential trades. 41 04:02.240 --> 04:08.450 If there is an important news for the United States dollar, like the non-farm payrolls for example, 42 04:08.930 --> 04:12.200 you can be sure that the dollar will drive the market. 43 04:12.200 --> 04:14.850 So the correlation will get stronger. 44 04:15.050 --> 04:21.170 So if you are thinking to open position or Euro-dollar and pound-dollar on the day of the non-farm 45 04:21.170 --> 04:25.340 payrolls, it is probably not a good idea. 46 04:25.340 --> 04:32.480 Another important thing to consider is the time horizon for your trade. Usually correlation is not so 47 04:32.480 --> 04:36.860 important if you plan to close your trade in minutes or hours. 48 04:36.980 --> 04:42.970 It becomes more important if you are planning to keep your trade open for days or weeks. 49 04:42.980 --> 04:48.890 Here we have two charts: euro-dollar on the left and pound-dollar on the right. 50 04:48.890 --> 04:51.910 Both of them have a five minute timeframe. 51 04:52.100 --> 04:57.110 You can see that even if you can find some similarities in these two charts, 52 04:57.240 --> 05:04.400 euro-dollar is going up forming higher lows. Pound-dollar seems not to have a clear trend at the 53 05:04.400 --> 05:10.660 moment and anyway it is forming lower lows, so just the opposite of euro-dollar. 54 05:11.050 --> 05:17.830 If we increase the timeframe like four hours, we can see that it is very easy to find a correlation 55 05:17.830 --> 05:20.300 between these two currency pairs. 56 05:20.410 --> 05:27.050 Movements are very similar and, in general, the market seems to follow the same direction. 57 05:27.070 --> 05:35.250 So the final question is: should you open trades with currency pairs that have a strong correlation? 58 05:35.530 --> 05:38.430 The answer is: it depends. 59 05:38.740 --> 05:45.440 If you have important news during the day that can affect the currency pair that is in both your trades, 60 05:45.490 --> 05:49.180 maybe it is better to trade just one currency pair. 61 05:49.240 --> 05:56.020 If you are planning to keep your trade for several days or several weeks, then, once again, probably it 62 05:56.020 --> 06:03.070 is better to open just one trade or another solution could be to split the risk between those two currency 63 06:03.070 --> 06:04.300 pairs. 64 06:04.330 --> 06:10.990 If it is not one of the cases that I have mentioned, I think that correlation is a bit overrated and 65 06:10.990 --> 06:14.370 I honestly don't really mind about it that much.