Currency Correlations: A Guide to Forex Profitability

1.Positive correlation occurs when two or more currency pairs move in the same direction simultaneously. For example, if EUR/USD is rising, GBP/USD is likely rising as well.

2.Negative correlation happens when two or more currency pairs move in opposite directions at the same time. For example, if EUR/USD is increasing, the US Dollar Index (DXY) is often decreasing.

How Can Currency Correlation Help Us Trade Profitably?

Since we know a pair is positively/negatively correlated with another we can look for hints the market leaves behind before a move happens. Woah no way???

What are these hints?

If a pair is positively correlated with another both should be making higher highs or lower lows at the same time. For example view the 4H chart below comparing EUR/USD and GBP/USD

http://i1083.photobucket.com/albums/...ps249fd2f8.png

Each higher high or lower low is happening at the same time stamp!

Knowing this one must ask him/her self what happens when one currency pair fails to follow the above pattern. For example lets say GBP/USD makes a higher high while EUR/USD makes a lower high. This is defined as a crack in correlation or falling out of correlation. Whichever you prefer. Please view the chart below demonstrating how this looks.

http://i1083.photobucket.com/albums/...ps4195dbd1.png

This is exactly the type of situation we are looking for. When two positively correlated pairs fall out of correlation at a major support or resistance level we can expect a reversal. This reversal may be as small as 25 pips but more often than not it results in larger moves. For example today's price action below.

http://i1083.photobucket.com/albums/...pse6c87c22.png