Asset correlation

What correlation is

Correlation shows how two or more things are connected. In currency trading it tells you whether two pairs move in sync. A high correlation means both pairs tend to rise and fall together. The correlation coefficient measures the strength and direction of the relationship: close to 1, the pairs move in the same direction; close to minus 1, in opposite directions; close to 0, there is little or no relationship.

Reading the table

A correlation table compares the currencies on one axis with those on the other, and each cell is the correlation between the two pairs. EUR/USD and GBP/USD have a correlation of 77: they mostly move in the same direction. GBP/USD and EUR/GBP have a correlation of minus 90: they usually move in opposite directions.

Pairs never move identically, but strong correlations exist, and a trader who ignores them can buy GBP/USD and sell EUR/GBP believing they are two separate trades. With a correlation of minus 90 they are close to the same trade twice, so both win or both lose. Recognize the correlations before you size a position, so that you do not hedge yourself by accident or double your risk without meaning to.

Currencies and commodities

Correlated currencies and commodities can be traded as pairs to reduce market risk, and the links are worth knowing on their own.

• The US dollar and gold move inversely: when one rises, the other tends to fall.
• The Australian dollar, the Canadian dollar and the Russian ruble are tied to the prices of commodities such as gold and oil.
• The Australian dollar and gold have a strong positive correlation: when gold rises, the Aussie tends to rise too.
• The Swiss franc is strongly correlated with gold, since a significant part of Switzerland's money is backed by gold reserves.
• Oil moves the Canadian dollar and the Japanese yen in opposite directions: rising oil strengthens the Canadian dollar and weakens the yen.
• The Norwegian krone follows Brent oil, as Norway is a major oil exporter.

Newer commodity trends count as well: lithium for electric car batteries, for one, matters to anyone trading the currencies of the countries that mine it.

Your own exposure

When two of your open trades are correlated, you are carrying one position at twice the size. The Fundamentals page follows the drivers of each pair you hold, and your open trades sit together in the log, so you can see when two of them are really the same bet.