Here’s an example of a negative correlation between EURUSD & USD Index. Note that red and green arrow: when one is going up, the other is going down, that’s negative correlation:
HOW CURRENCY CORRELATION HELPS YOU TRADE PROFITABLY
Knowledge of currency co-relations will ensure that you do not take two positions that go against each other. For example, if you take a buy trade on EURUSD and also same time take a BUY trade on USDCHF without realizing that these two currencies are negatively correlated you will get into this problem:
- one trade on one currency pair will be profitable
- and the other trade will be unprofitable.
Your failure to fully understand the currency correlation will leave you with a trade you should not have taken in the first place. This mistake is usually made by newbie forex traders.
FOREX CORRELATION STRATEGY RULES
Currency Pairs: Only for positively correlated currency pairs like EURUSD and GBPUSD.
Timeframes: 15 minutes and above, lower time frames are not really reliable.
Additional Information: 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. So you should be watching these kinds of setups to happen around support and resistance levels.
Now, the setup shown here is based on a support level so its a BUY setup. If this happens on the resistance level, it will be a SELL setup, the exact opposite.
Step 1: EUR/USD made a lower low while GBP/USD has failed to do so.
Step 2: Wait for a retest of the divergence swing. No retest occurs so we set a limit order for a breakout trade.
Step 3: Entry is triggered. If you haven’t done so place a stop loss at the most recent swing low.
Step 4: Draw a fib on the diverging swing for profit levels. Don’t forget to trail your stop to break even. In this case, the risk was 35 pips so trail to break even at 25-30 pips. As you can see in this case all fib extensions were hit for a profit of 108 pips. Let's say you didn’t want to hold a position overnight so you got out when price started to consolidate after the strong up move. You would have made +75 pips.