How do currencies move in relation to each other?

The following is our monthly correlations update for November. As we have previously mentioned, correlations between different currency pairs shift over time, therefore it is of utmost importance to regularly follow changes in correlation. We have also included the 3 month and 1 year correlations to give traders a better sense of historical trends and added 6 month trailing correlations as further confirmation of the correlation results.

In order to be an effective trader, it is also important to understand how different currency pairs move in relation to each other. There are a few reasons why this is significant, but most importantly, it allows traders to understand their exposure. That is, having a portfolio that consists of the EURUSD and GBPUSD is different from having a portfolio that consists of the EURUSD and USDCHF. As indicated in the tables below, over the past year, the EURUSD has had a strong positive correlation (+0.96) with the GBPUSD and a strongly negative correlation with USDCHF (-0.99).

Therefore having a long EURUSD and long USDCHF exposure would generally lead to negated or nearly zero profit or losses because when the EURUSD rallies, USDCHF will sell off the majority of the time. Of course, these two currencies have different pip values, so the P/L may not be exactly zero. On the other hand, holding long EURUSD and long GBPUSD exposure is similar to doubling up on the position since the correlation is so strong.

Furthermore, we can tell from our tables that correlations shift with time. The GBPUSD and NZDUSD have a relatively strong positive correlation (0.83). This relationship broke down quite a bit this month however as we see a one month correlation of (0.14). Having this knowledge will allow traders to effectively diversify and manage their portfolios. Shifts such as these can be partially explained by changes in the severity of monetary policy or changes in unique domestic conditions.

Regardless of your trading strategy and whether you are looking to diversify your positions or find alternate pairs to leverage your view, it is very important to keep in mind the correlation between various currency pairs and their shifting trends.

Kathy Lien

Kathy Lien is the Chief Currency Strategist at Forex Capital Markets. Kathy is responsible for providing research and analysis for DailyFX, including technical and fundamental research reports, market commentaries and trading strategies. A seasoned FX analyst and trader, prior to joining FXCM, Kathy was an Associate at JPMorgan Chase where she worked in Cross Markets and Foreign Exchange Trading.

Kathy has vast experience within the interbank market using both technical and fundamental analysis to trade FX spot and options. She also has experience trading a number of products outside of FX, including interest rate derivatives, bonds, equities, and futures. She has a Bachelors degree in Finance from New York University. Kathy has written for Stocks and Commodities, CBS Market Watch, ActiveTrader, Futures and SFO Magazine. She is frequently quoted on Bloomberg and Reuters and has taught seminars across the country. She has also hosted trader chats on EliteTrader, eSignal, and FXStreet, sharing her expertise in both technical and fundamental analysis.