Currency Correlation in Forex: How to Use It for Better Trading
Currency correlation is one of the most powerful yet underutilized tools in forex trading. Understanding how currency pairs move in relation to each other can help you diversify risk, confirm trades, and avoid accidentally doubling your exposure. This guide covers everything you need to know about using correlation in your trading.
What Is Currency Correlation?
Currency correlation measures the degree to which two currency pairs move in relation to each other. Correlation is expressed as a coefficient ranging from -1 to +1:
- +1 (Perfect Positive): Pairs move identically in the same direction
- 0 (No Correlation): Pairs move independently
- -1 (Perfect Negative): Pairs move identically in opposite directions
Understanding Correlation Values
| Value | Interpretation |
|---|---|
| +0.8 to +1.0 | Strong positive correlation |
| +0.6 to +0.8 | Moderate positive correlation |
| +0.4 to +0.6 | Weak positive correlation |
| -0.4 to +0.4 | Little to no correlation |
| -0.4 to -0.6 | Weak negative correlation |
| -0.6 to -0.8 | Moderate negative correlation |
| -0.8 to -1.0 | Strong negative correlation |
Why Correlation Matters
Risk Management
If you're long EUR/USD and long GBP/USD, you don't have two independent positions. These pairs are highly correlated (typically +0.85 to +0.95). If the USD strengthens, both trades lose.
Example of Hidden Risk:
Position 1: Long EUR/USD 1 lot (risking 1%)
Position 2: Long GBP/USD 1 lot (risking 1%)
You think you're risking 2% total
Reality: Because of correlation, you're closer to risking 2% on a single USD move
Trade Confirmation
Correlation can confirm trade signals. If you see a bullish setup on EUR/USD, and GBP/USD is also showing bullish signals, the USD weakness theme is confirmed.
Hedging Opportunities
Negatively correlated pairs can hedge each other. Understanding correlation helps construct positions that offset certain risks.
Major Currency Pair Correlations
Highly Correlated Pairs (Positive)
EUR/USD and GBP/USD (+0.85 to +0.95) Both are "anti-dollar" pairs. When USD weakens, both tend to rise.
EUR/USD and AUD/USD (+0.70 to +0.85) Similar dynamic—both move inversely to USD.
AUD/USD and NZD/USD (+0.90 to +0.98) Very high correlation due to geographic and economic ties.
EUR/JPY and GBP/JPY (+0.85 to +0.95) Both involve JPY as the quote currency.
Highly Correlated Pairs (Negative)
EUR/USD and USD/CHF (-0.85 to -0.95) Near mirror images—when one rises, the other falls.
GBP/USD and USD/CHF (-0.80 to -0.90) Similar inverse relationship.
AUD/USD and USD/CAD (-0.60 to -0.75) Both commodity currencies but on opposite sides of USD.
Less Correlated Pairs
EUR/GBP and USD/JPY (Close to 0) These pairs often move independently, offering true diversification.
EUR/CHF and AUD/NZD (Close to 0) Limited correlation provides portfolio diversification.
How to Calculate Correlation
Using Excel or Google Sheets
- Export daily closing prices for both pairs
- Use the CORREL function
- Apply to the last 20-100 days of data
=CORREL(A2:A101, B2:B101)
Online Correlation Tools
Many resources provide real-time correlation matrices:
- Myfxbook Correlation
- Investing.com Forex Correlation
- OANDA Currency Correlation Table
MetaTrader 5 Correlation Indicators
Various free and paid indicators display live correlation between pairs directly on your charts.
Correlation-Based Trading Strategies
Strategy 1: Correlation Confirmation
Use correlated pairs to confirm trade signals.
Setup:
- Identify a trade setup on your primary pair
- Check correlated pair for similar setup
- Only trade if both show the same direction
Example:
Primary: EUR/USD shows bullish engulfing at support
Check: GBP/USD also showing bullish signals at support
Action: Increased confidence in EUR/USD long
If GBP/USD showing bearish signs while EUR/USD bullish:
Action: Reduced confidence, consider passing on trade
Strategy 2: Divergence Trading
When normally correlated pairs diverge, it often corrects.
Setup:
- Monitor highly correlated pair (e.g., EUR/USD and GBP/USD)
- Wait for unusual divergence
- Trade the expectation of convergence
Example:
Normal state: EUR/USD and GBP/USD moving together
Divergence: EUR/USD rises while GBP/USD stays flat
Analysis:
- Check for GBP-specific news (explains divergence)
- If no news, expect GBP/USD to catch up
Trade: Long GBP/USD, expecting it to follow EUR/USD higher
Caution: Always investigate WHY a divergence occurred before assuming mean reversion.
Strategy 3: Pairs Trading
Trade the relative value between two correlated pairs.
Setup:
- Calculate the ratio between two correlated pairs
- Identify when ratio deviates from average
- Trade expecting mean reversion
Example with EUR/USD and GBP/USD:
Normal ratio: EUR/USD / GBP/USD = ~0.87
Current ratio: 0.92 (EUR/USD is relatively expensive)
Trade: Short EUR/USD, Long GBP/USD (ratio neutral to USD)
Target: Profit when ratio returns to 0.87
This is market-neutral regarding USD direction—you profit from the ratio normalizing.
Strategy 4: Portfolio Diversification
Build positions that provide genuine diversification.
Poor Diversification (Highly Correlated):
- Long EUR/USD
- Long GBP/USD
- Long AUD/USD
All three move together—you're essentially tripling USD exposure.
Better Diversification (Mixed Correlation):
- Long EUR/USD
- Short USD/JPY (both anti-USD, but different dynamics)
- Long USD/CAD (provides opposite exposure)
Or trade cross pairs to reduce USD dependency:
- EUR/JPY
- GBP/CHF
- AUD/NZD
Correlation and Position Sizing
Combined Position Risk
When trading correlated pairs simultaneously, adjust position sizes:
Formula for Highly Correlated Positions:
Adjusted Risk = Single Position Risk × √(n)
Where n = number of correlated positions
Example: 3 highly correlated positions at 1% risk each
Adjusted Risk ≈ 1% × √3 = 1.73% effective risk
Not 3% (simple addition), but not 1% either (diversification benefit)
Practical Guidelines
| Correlation | Position Sizing Approach |
|---|---|
| Above +0.7 | Treat as single position for risk purposes |
| +0.3 to +0.7 | Reduce combined size by 25-50% |
| -0.3 to +0.3 | Can use full position sizes (true diversification) |
| Below -0.3 | Positions provide hedging benefit |
What Causes Correlations to Change?
Economic Regime Changes
During risk-off environments, correlations between "risk" currencies (AUD, NZD) and "safe-haven" currencies (JPY, CHF) become more pronounced.
Central Bank Policy Divergence
When central banks move in different directions, normal correlations can break down.
Example: If the ECB raises rates while the Bank of England holds, EUR/GBP dynamics shift, affecting EUR/USD and GBP/USD correlation.
Major Political Events
Brexit significantly altered GBP correlations with EUR pairs during the 2016-2020 period.
Commodity Price Movements
AUD and CAD correlations with other pairs fluctuate with commodity prices, particularly during oil or iron ore price shocks.
Practical Tips for Using Correlation
Monitor Correlation Regularly
Correlations are not static. Review weekly or monthly:
- Has the correlation strengthened or weakened?
- Are there divergences building?
- Has a regime change occurred?
Use Multiple Timeframes
Daily correlation may differ from hourly correlation:
- Long-term trading: Use daily or weekly correlation
- Intraday trading: Use hourly correlation
Don't Over-Rely on Correlation
Correlation is a historical measure—it tells you what happened, not what will happen:
- Past correlation doesn't guarantee future correlation
- Unexpected news can break correlation instantly
- Use as one tool among many, not the sole decision factor
Combine with Fundamental Analysis
When correlations break down, fundamental analysis explains why:
- Interest rate differential changes
- Economic data surprises
- Political developments
- Risk sentiment shifts
Common Correlation Mistakes
Mistake 1: Assuming Correlation Is Causation
EUR/USD and GBP/USD are correlated, but EUR/USD doesn't cause GBP/USD to move. Both are responding to USD dynamics.
Implication: Don't expect one to "pull" the other—both respond to underlying factors.
Mistake 2: Ignoring Correlation Changes
Using last year's correlation for today's trading can be dangerous.
Solution: Use rolling correlation with shorter lookback periods (20-50 days) for recent dynamics.
Mistake 3: Over-Hedging
Taking opposite positions in highly negatively correlated pairs:
Long EUR/USD + Long USD/CHF = Nearly offsetting positions
Result: Paying spreads on both with minimal profit potential
Solution: Only hedge when you have a specific risk exposure to offset.
Mistake 4: Forcing Correlation Into Trading
Not every trade needs a correlation check. Simple setups often work fine without overcomplicating with correlation analysis.
Solution: Use correlation for risk management and position sizing, not as a primary entry trigger.
Conclusion
Currency correlation is a powerful concept that most retail traders underutilize. Understanding how pairs move together allows you to:
- Manage portfolio risk by avoiding accidental concentration
- Confirm trade ideas using correlated pair analysis
- Diversify effectively with uncorrelated positions
- Identify opportunities when correlations diverge
Start by understanding the major correlations in the pairs you trade. Monitor them regularly and adjust your position sizing when trades are highly correlated.
Remember: correlation is a tool for risk management, not a trading system. Use it to make your existing strategies more robust, not as a standalone approach.
Master correlation, and you'll trade with a more sophisticated understanding of how the forex market truly works.