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FOREX “CLIFF” NOTES

Currency Pairs Correlation in Forex Market:Cross Currency Pairs

By Vahid | Category: Forex Basics | Tuesday, August 25th, 2009

As a forex trader, if you check several different currency pairs to find the trade setups, youshould be aware of the currency pairs correlation, because of two main reasons:

1- You avoid taking the same position with several correlated currency pairs at the same timeand so you do not multiply your risk. Additionally, you avoid taking the positions with thecurrency pairs that move against each other, at the same time. 2- If you know the currency pairscorrelations, it may help you to predict the direction and movement of a currency pair, throughthe signals that you see on the other correlated currency pairs.

 Now I explain how currency pairs correlation helps. Lets start with the 4 major currency pairs:EUR-USD ; GBP-USD ; USD-JPY and USD-CHF.

In both of the first two currency pairs (EUR-USD and GBP-USD), USD works as the money. Asyou know, the first currency in currency pairs is known as the commodity and the second one isthe money. So when you buy EUR-USD, it means you pay USD to buy Euro. In EUR-USD andGBP-USD, the currency that works as the money is the same (USD). The commodity of these pairs are both related to two big European economies. These two currencies are highly connectedand related to each other and in 99% of the cases they move on the same direction and form thesame buy/sell signals. Just recently, because of the economy crisis, they moved a little differently but their main bias is still the same.

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What does it mean? It means if EUR-USD shows a buy signal, GBP-USD should also show a buy signal with minor differences in the strength and shape of the signal. If you analyze themarket and you come to this conclusion that you should go short with EUR-USD and at the sametime you decided to go long with GBP-USD, it means something is wrong with your analysisand one of your analysis is wrong. So you should not take any position until you see the same

signal in both of these pairs. Of course, when these pairs really show two different direction(which rarely happens), it will be a signal to trade EUR-GBP. I will tell you how.

Accordingly, USD-CHF and USD-JPY behave so similar but not as similar as EUR-USD andGBP-USD, because in USD-CHF and USD-JPY, money is different. Swiss Franc and JapaneseYen have some similarities because both of them belong to oil consumer countries but thevolume of industrial trades in Japan, makes JPY different.

Generally, when you analyze the four major currency pairs, if you see buy signals in EUR-USDand GBP-USD, you should see sell signals in USD-JPY. If you also see a sell signal in USD-CHF, then your analysis is more reliable. Otherwise, you have to revise and redo your analysis.

EUR-USD, GBP-USD, AUD-USD, NZD-USD, GBP-JPY, EUR-JPY, AUD-JPY and NZD-JPYusually have the same direction. Just their movement pattern sometimes becomes more similar toeach other and sometimes less.

What do I prefer?

If I find a sell signal with EUR-USD and GBP-USD and a buy signal with USD-JPY, I prefer totake the short position with one of the EUR-USD or GBP-USD because downward movementsare usually stronger. I will not take the short position with EUR-USD or GBP-USD and the long position with USD-JPY at the same time, because if any of these positions goes against me, the

other one will do the same. So I don’t double my risk by taking two opposite positions with twocurrency pairs that move against each other.

How to use the currency pairs correlation to predict the direction of the market?

When I have a signal with a pair, but I need confirmation to take the position, I refer to thecorrelated currency pairs or cross currency pairs and look for the confirmation. For example I seea MACD Divergence in USD-CAD four hours chart but there is no close support breakout inUSD-CAD four hours or one hour chart. I want to take a short position but I just need aconfirmation. If I wait for the confirmation, it can become too late and I may miss the chance. Icheck a correlated currency pair like USD-SGD and if I see a support breakout in it, I take the

short position with USD-CAD. Now the question is why I don’t take the short position withUSD-SGD and I use its support breakout to go short with USD-CAD? I do it because USD-CADmovements are stronger and more profitable. I use USD-SGD just as an indicator to trade USD-CAD.

It happens that you take a position with a currency pair, but it doesn’t work properly and youdon’t know if it was a good decision or not. On the other hand, you don’t see any sharp signal onthat currency pair to help you decide if you want to keep the position or close it. In such cases,

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you can check a correlated currency pair and look for a continuation or reversal signal. It helpsyou to decide about the position you have.

Sometimes, some correlated currency pairs don’t move in the way that they are supposed tomove. For example EUR-USD and USD-JPY go up at the same time, whereas they usually move

against each other. It can happen when Euro value goes up and USD value doesn’t have asignificant change, but at the same time JPY value goes down, because of some reason. In thesecases, you can use the below table to find and trade the currency pair that its movement isintensified by an unusual movement in two other currency pairs. In this example, if EUR-USDand USD-JPY go up at the same time, EUR-JPY will go up much stronger (see the below chart).

Or if EUR-USD goes up and AUD-USD goes down at the same time, EUR-AUD goes upstrongly.

Another important example: If EUR-USD goes up and GBP-USD goes down at the same time,EUR-GBP goes up strongly. Maybe this is the most important case that we can trade based on

this rule. It happens many times that EUR-USD and GBP-USD move against each other and thatis the best time to trade EUR-GBP. Now you know why EUR-GBP doesn’t move strongly mostof the time. It is because EUR-USD and GBP-USD move in the same direction most of the time.For example they go up at the same time and so EUR-GBP doesn’t show any significantmovement because when both of the currencies of a currency pair go up or down at the sametime, that currency pair doesn’t show any strong movement and direction (I hope you know whya currency pair goes up or down. It goes up when the first currency value goes up OR the secondcurrency value goes down. For example EUR-USD goes up, if Euro value goes up or USD valuegoes down. If this happens at the same time, then EUR-USD goes up much stronger).

The below chart includes almost all of these unusual movements and their results on the third

currency pair.

if EUR-USD andUSD-JPY then EUR-JPY means if EUR-USD and USD-JPY go up at thesame time, then EUR-JPY goes up much stronger.

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By Vahid | Category: Forex Basics | Tuesday, August 25th, 2009

Currency pairs are among the most popular questions I am always asked. Sometimes it surprisesme how someone wants to trade forex while he/she still doesn’t know about currency pairs. But Ishould not be surprised, because we always focus on advanced topics like technical analysis,candlesticks and indicators and … that we forget about the basics. We do not consider that beginners may have difficulties in understanding the currency pairs that are the foundation of forex and forex trading.

What are the currency pairs in the forex world?

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In stock market, you trade shares of companies. You buy and sell them. You pay money to buystocks. But what if you wanted to trade or buy and sell a currency?

In the stock market, companies’ shares are commodities and the currency you pay to buy them isthe money. It is the same in any other kind of trading. You pay money to buy a commodity. In

forex or foreign currency exchange, you trade currencies. So again, you have to pay something to buy something else. You pay a currency to buy another currency. You sell a currency againstanother currency. To be able to do that, they have created currency pairs. For example EUR-USD is a currency pair. In each currency pair, the first currency is the commodity and the secondcurrency is the money. In EUR-USD, the first currency which is Euro is the commodity and thesecond currency which is USD is the money. When you buy EUR-USD, in fact you pay USD to buy Euro. No matter in what currency your forex trading account is. You can have a tradingaccount in USD, GBP, CAD or any other currency. When you want to buy EUR-USD, your  broker changes your trading account capital into USD and then pays that USD to buy Euro. Thisis how it works. Any trade in forex market has to be done through USD. US dollar is the maincurrency and is the axis of all transactions in the forex market. Any currency pair that you buy or 

sell has to be done through USD. However, all of these process will be done automatically andyou just need to click on the buy or sell buttons.

Lets get back to our example, EUR-USD. I told you that when you buy EUR-USD, in fact you pay USD to buy Euro or you buy Euro against USD. In forex market it is possible to sell EUR-USD even before you buy it. How? Let me give you an example. You borrow my car for twoweeks. Suddenly you see someone wants to buy the car from you with a good price like $5000above the real price. You sell my car. But you have to return my car after two weeks, right?When it is time to return my car, you go and buy the same car exactly, but with the real pricewhich is $5000 lower than the price that you sold my car. You return my car while you havemade a $5000 profit.

This is what we do when we sell a currency pair before we buy it. You sell EUR-USD high and buy it low. You sell it low and buy it lower.

When you buy a currency pair, you take a “long” position and when you sell a currency pair, youtake a “short” position. Long and short are just the terms we use in forex and stock market andthey have nothing to do with the length of anything. They are just terms. Of course usually ittakes longer for the price to go up and shorter to go down. That’s why when you buy, they sayyou have a long position because it may take a long time for the price to go up. And when yousell, they say you have a short position because it may take a shorter time for the price to godown.

Anyway! So when we say we go long with EUR-USD it means we buy it and visa versa.

Now lets answer the “frequently asked questions” I always receive about

currency pairs:

1. What are the forex major currency pairs? There are four major currency pairs in the forexmarket: EUR-USD ; GBP-USD ; USD-JPY and USD-CHF.

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2. What are the most popular currency pairs? Among the four major currency pairs, EUR-USD is the most popular and has the highest volume of transactions. They say more than 70% of transactions in the forex world is focused on EUR-USD. But it doesn’t mean that 70% of  personal forex trader like you and me trade EUR-USD only. Forex market is not limited to whatforex traders do. In fact, forex traders are a very small portion of the forex market. The big

transactions are done by the big InterBanks and central banks. Sometimes they do it not becauseof making profit, they do it because they have to. Sometime a country has to sell its owncurrency against another currency to lower its currency value and control its price.

The most popular currency among personal forex traders is GBP-JPY and EUR-JPY and alsoGBP-USD. GBP-JPY is the king of the currency pairs for private forex traders. The reason is it isso volatile and strong. Its trading signals are sharp and strong and it has a wide movement scale.Forex traders trade GBP-JPY to make more profit, but this sword has two sharp edges. Your losses can also be bigger.

3. What are the most liquid currency pairs? EUR-USD is the most liquid currency pair 

 because it has the highest trading volume. However, you will not have any liquidity problem inthe forex market because it is such a huge market. It is not like the stock market that sometimesyou can not find a buyer for the shares that you have already bought and you want to sell.

4. What are the most active currency pairs or the most volatile currency pairs? As I said,GBP-JPY is the most active and the most volatile currency pair. EUR-JPY has the second position in volatility and activity. GBP-JPY and EUR-JPY usually have the same direction. Itmeans when one of them goes up the other one goes up too and visa versa. GBP-JPY and thenEUR-JPY are the most traded currency pairs among forex traders.

5. What are the best currency pairs to trade? I don’t know about the other traders, but if you

ask me about the best currency pairs to trade, I say any currency pair that shows a strong andsharp signal at a time, is the best currency pair to trade. I see some traders who fall in love with aspecial currency pair and try to trade only that one. This is wrong. You limit yourself and ignorethe free opportunities that the forex market has given you. There are several currency pairs onthe forex market that you can trade. Why should you ignore all of them and focus on one pair?

They say you should focus on one currency pair and “master” it. This is another “nonsense idea”.Currency pairs are not like different jobs that you have to focus and master one of them. It hasthe the same rules and techniques for all of the currency pairs trading. A support line breakout isa sell signal in any currency pair. Find a valid support line in a currency pair and go short after its breakout. No matter what currency pair it is. You make money. Of course don’t forget to set

your stop loss

All joking aside! Do not believe everything you read and hear. Some people start writing articlesand e-books when they give up on becoming a profitable forex trader. So they try to make moneythrough selling their e-books and forex training courses. Unfortunately 95% of the books, articlesand training courses are written and managed by these people. And those articles, books andtraining courses are the main sources of “nonsense ideas” like the one that I explained above.

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Anyway

6. What are the best times to trade currency pairs? Again I have my own answer to thisquestion and my answer can be different from the others’ answer you may find over the internet.The best time to trade a currency pair is when it forms a strong and sharp signal. Period!

This question is mainly asked by intraday traders who trade using small time frames like 5min or 15min. They want to have a trading session every day and they do not like to have any open position during the night. Whether I agree with this idea or not, I will not focus on it here because this article is about currency pairs.

There are three main sessions in forex market: London session, New York session and Asiansession. London session is from 8am to 4am GMT. New York session is from 8am to 4pm ESTand Asian session is from 7pm to 3am EST. Forex market has the highest volatility when both of the London and New York markets are open which is about 8am to 1pm EST. Then at 4pm ESTthat they close the New York, the forex market becomes so slow. But after a few hours, Japan

and then Australia start working and so forex market becomes volatile again.

Back to the question that “what are the best times to trade currency pairs?”, I have to say thatwhen forex market become active and volatile, all of the currency pairs move, not just somespecial currency pairs. It doesn’t matter what session it is. So basically this question is not acorrect question. You can trade any currency pair when market is moving and there is a forexsignal.

7. What are the exotic currency pairs? USD-SEK (Swedish krona), USD-DKK (Danish krone)and USD-NOK (Norwegian krone) are the most famous exotic currency pairs. They are calledexotic because of their  pip value. Their pip value is much smaller than the other currency pairs

like EUR-USD. When you trade one of these pairs for the first time, you may not believe your eyes when you calculate your stop loss and take profit. A stop loss that has to be placed abovethe previous candlestick , has a several hundreds of pips value. But don’t scare. Those pips arenot like the ones your see in other currency pairs. I call them mini pips. They are about 1/10 of the value of the normal pips.

Exotic currency pairs are not limited to those three. EUR-NOK, EUR-SEK, EUR-DKK and

GBP-NOK, GBP-SEK and GBP-DKK are even more exotic

There are also many other exotic currency pairs like USD-RUB (Russian Ruble), USD-CCK (Czech Krouna), USD-HKD (Hong Kong Dollar), USD-HUF (Hungarian Forint), USD-LVL

(Latvian Lats), USD-MXN (Mexican Pesos), USD-PLN (Polish Zloty), USD-ZAR (SouthAfrican Rand) and … … … .

8. Do you have the currency pairs list? Each forex broker supports different number of currency pairs. However all of them support the 4 major currency pairs and most of the other  popular and known currency pairs. Here is the list of the currency pairs that I check every day inForexoma Live Market Analysis:

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EUR-USDGBP-USDAUD-USD NZD-USD

USD-JPYGBP-JPYEUR-JPYCAD-JPYAUD-JPY NZD-JPY

USD-CADEUR-CADGBP-CAD

USD-CHFEUR-CHFGBP-CHFCAD-CHF

USD-SGDUSD-DKK USD-SEK USD-NOK 

EUR-AUD

GBP-AUD

EUR-GBPAUD-NZD

9. What are the cross currency pairs and what is the currency pairs correlation? Learnabout currency pairs correlation here.

Further Reading: Before leaving

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