When two currency pairs are correlated, their prices move in the same direction most of the time. This correlation can be positive or negative, depending on whether the two currency pairs’ prices drive in the same order or opposite directions.
Many factors can cause a currency pair to be correlated with another. For example, if two countries have similar economies, their currencies will likely be correlated. Or, if two countries have political relationships, their cash will likely be correlated.
Some common correlations between currency pairs include:
- The Euro and the British Pound (EUR/GBP) are positively correlated because they are major European currencies.
- The Australian Dollar and the U.S. Dollar (AUD/USD) are negatively correlated because Australia is a significant exporter of metals and minerals, which compete with the U.S. as a commodity producer.
- The Canadian Dollar and the Japanese Yen (CAD/JPY) are negatively correlated because Canada exports more to Japan’s competitor, China, than it does to Japan itself.
Correlation between two currency pairs
When two currency pairs are not correlated, their prices move independently from each other. This independence can be positive or negative, depending on whether the two currency pairs’ prices move in the same direction or opposite directions.
Many factors determine whether a pair will be positively or negatively correlated with another pair; however, one of the main factors that affect currency pairs’ correlativity is the distance between the two currency pairs. For example, a USD/CAD currency pair will be more correlated than a USD/CHF currency pair because a U.S. Dollar and a Canadian Dollar are much closer together than a United States Dollar and a Swiss Franc.
When trying to determine whether or not there is a correlation between two currency pairs, it is essential to look at the percentage change in prices over time rather than just price fluctuations from one day to another. This percentage change gives traders a better idea of how correlated two currency pairs are with each other over different lengths of time.
For example: If EUR/USD moves from 1.3050 to 1.3150 over a period of one week, that is considered to be relatively correlated because the pair only fluctuated ten pips. However, suppose EUR/USD moves from 1.3050 to 1.3250 over a period of six weeks. In that case, that is considered to be relatively not correlated because the pair moved 100 pips during this time frame and may move in opposite directions even though they were positively correlated for half of it (a significant factor would probably be the fact that six weeks is a long time when considering such small pips).
Regression analysis
The most common way traders measure the correlation between two currency pairs is through regression analysis; however, there are also more straightforward ways such as using charts and observing price movements which can give you significant insight into how correlated two currency pairs are.
It is important to note that correlation between currency pairs does not always remain static and may change with external factors such as interest rate announcements or political events. Traders should consider these external factors when trading two correlated currency pairs simultaneously because they may cause the prices of both currency pairs to move in opposite directions rather than going up or down together. For a better understanding in trading, contact Saxo for more info!
For example: If a British Pound is a British Treasury bond, yields go up, its price will likely decrease while the U.S. Dollar’s price will likely increase because the U.S. bond yield has been on an upward trend for some time now. In other words, this would be considered an “uncoupling” of the positive correlation between the two currency pairs.