In the world of forex trading, understanding currency correlations is key to minimizing risk and maximizing profit potential. For beginners especially, misunderstanding these correlations can significantly increase risk. This article will discuss various aspects of currency correlations, including commodity currencies, cross pairs, exotic currencies, and how to select the right currency pairs based on trading time and needs.
What is Currency Correlation?
Currency correlation refers to the relationship between the price movements of one currency and another. Understanding this helps traders make more informed trading decisions and manage risks more effectively.
For example, buying EUR/USD and GBP/USD simultaneously can increase risk if both pairs move in the same direction. On the other hand, buying EUR/USD and selling USD/CHF at the same time can also magnify risk. These correlations must be carefully considered to avoid unnecessary risk exposure.
Commodity Currencies
Commodity currencies are those whose value is heavily dependent on the export of commodities, such as mining or agricultural products. In forex, commodity currencies include pairs like AUD/USD, USD/CAD, and NZD/USD. Additionally, commodities like gold (XAU/USD) and silver (XAG/USD) also fall into this category. These currencies tend to have a positive correlation with the price of the commodities they produce.
- AUD/USD has a positive correlation with gold prices (XAU/USD).
- USD/CAD correlates positively with global crude oil prices.
Understanding these correlations is important for traders who want to take positions based on the underlying commodity price movements.
Cross Currency Pairs
Cross currency pairs involve trading between two major currencies that do not include the US Dollar. Some examples of cross currency pairs include:
- AUD/CAD – Australian Dollar vs. Canadian Dollar
- EUR/JPY – Euro vs. Japanese Yen
- GBP/JPY – British Pound vs. Japanese Yen
- EUR/GBP – Euro vs. British Pound
Cross pairs are often traded because they offer different trading opportunities compared to major pairs involving USD. Some of the most frequently traded cross pairs include EUR/JPY, AUD/JPY, GBP/JPY, and NZD/JPY.
Exotic Currency Pairs
Exotic currency pairs involve a major currency from a developed country paired with the currency of a developing country. Some commonly traded exotic pairs include:
- USD/TRY – US Dollar vs. Turkish Lira
- USD/ZAR – US Dollar vs. South African Rand
- EUR/TRY – Euro vs. Turkish Lira
The downside of trading exotic currency pairs is the high spreads and low liquidity, so forex traders are often more cautious when selecting these pairs.
How to Choose the Right Currency Pairs
When selecting the currency pairs to trade, consider the following factors:
Trading Plan: Align your choices with your trading plan. For instance, if you’re interested in comparing the strength of the Euro, you might monitor pairs like EUR/USD, EUR/JPY, and EUR/GBP.
Watch List: Use the Watch List in your trading platform to keep an eye on pairs relevant to your strategy. Platforms like MetaTrader 4 allow traders to create Watch Lists, making it easier to track price movements.
Right Time to Trade: Choose your trading time based on periods of high volatility. Pay attention to market sessions (Asia, London, and New York) and the overlap periods to take advantage of more active market movements.
Understanding currency correlations is a critical skill for traders to manage risk and maximize profits. By knowing the relationships between different currencies, including commodity currencies, cross pairs, and exotic pairs, and by selecting the right pairs based on timing and strategy, you can make more informed and effective trading decisions.
