Forex Trading Correlation Strategies

Expert: Dan Blystone, Founder at TradersLog.com

Who is Dan Blystone?
Dan Blystone is founder of TradersLog.com - a website that focuses on technical and fundamental analysis of the financial markets, and also features a forum and chatroom.

Originally from London and now based in Chicago, Dan was previously a professional futures trader. He worked on the floor of the Chicago Mercantile Exchange in the currencies and the S&P pit, later traded Eurex's bund futures, and most recently traded the US 10 year note futures. Having also worked at ABN AMRO's interbank desk in Chicago, Dan has a keen interest in the world of forex trading and has enjoyed working with FXStreet.com over the past year.

Transcript Session:

Moderator_FXstreet
Good morning, good afternoon, and good evening to all of you joining us today from different parts of the world. I want to welcome all of you to today's Live Forex Expert Question and Answers session.

Moderator_FXstreet
Welcome to FXstreet.com Q&A Forex Session.

Moderator_FXstreet
Please prepare any questions you may have for the expert. Thank you for joining today s Q&A Session.

Moderator_FXstreet
Welcome to the Session. Today I am delighted to welcome our guest speaker Dan Blystone, Founder at TradersLog.com.

Dan_Blystone
Welcome to this weeks session!

Dan_Blystone
Some great volatility in the market recently

Dan_Blystone
500 pip range in the GBP/USD yesterday!

Dan_Blystone
We'll get started in a couple of minutes

Dan_Blystone
Right, lets get started in our discussion of todays topic

Dan_Blystone
correlation strategies and how they can help you trade better

Dan_Blystone
we'll start by looking at commodites and their relationship to the fx market

Dan_Blystone
Gold and oil in particular have an important relationship with the forex market, and can be used as leading indicators in forex trading. Four major currencies are considered to be the closest tied to commodity prices - the Australian Dollar, the Canadian Dollar, the New Zealand Dollar and the Swiss Franc.

Dan_Blystone
Gold and it's relationship to the Forex Market

Dan_Blystone
While the US is the world's second largest producer of gold, after South Africa, gold normally does not move in line with the US Dollar, rather they tend to have an inverse relationship. This is because during periods of geopolitical uncertainty traders tend to migrate away from the US Dollar and towards gold as a safe haven.

Dan_Blystone
In the world of Forex, no major currency is considered to be as safe and stable as the Swiss Franc. The political neutrality of the Swiss and the fact that 40% of its currency reserves were previously backed by gold underpin the Swiss Franc's image as being a safe haven during periods of uncertainty. For these reasons the CHF/USD has a strong positive correlation with gold prices.

Dan_Blystone
The AUD/USD, NZD/USD, USD/CHF currency pairs tend to trade in line with gold the closest, due to the other currency having close political and natural ties to gold.

Dan_Blystone
Oil and it's relationship to the Forex Market

Dan_Blystone
Canada's total crude oil reserves stand in second place behind Saudi Arabia.

Dan_Blystone
The Canadian Dollar is the currency most influenced by rising oil prices- if oil prices rise the CAD is likely to closely follow.

Dan_Blystone
Rising oil prices benefit the Canadian economy as it takes in more money for oil and raises profits for domestic oil companies.

Dan_Blystone
The US imports 85% of Canada's oil exports. Rising oil prices have in part caused the Canadian dollar to rise to a 28 year high against the US dollar.

Dan_Blystone
now lets look for a minute at correlations between the currency pairs themselves

Dan_Blystone
Very often currency pairs are closely related to one another - and this is something that can be used to the Forex Traders advantage.

Dan_Blystone
Correlation analysis helps you understand these relationships. Positive and negative correlations between currency pairs are measured in decimal form - and they serve to reflect the extent to which the pairs 'trade in line' or diverge with eachother.

Dan_Blystone
The closer the number is to 1, the stronger the positive correlation.

Dan_Blystone
Conversely - the closer the number is to -1 the stronger the negative correlation. Currency correlations are measured over a specific time periods, and it is important to bear in mind that these relationships reflected in the numbers will change over time.

Dan_Blystone
Correlations can help a forex trader manage their risk exposure - by using a pair with a negative correlation as a hedge. A positive correlation between two currency pairs can be used as a leading indicator.

Dan_Blystone
mataf.net does a great job of tabulating the corellations between the currencies - you can see the tables here:

Dan_Blystone
http://www.mataf.net/en/analysis-correlation.htm

Dan_Blystone
as you can see they have covered multiple time frames - 5 days, 10days, 100 days etc

Dan_Blystone
so looking at the 100 day table, you can see for example that

Dan_Blystone
eur/usd has a very stong positive corellation with aud/usd (88+)

Dan_Blystone
that concludes my discussion of correlation - I'd like to move on to a couple more topics before we move to q&a

Dan_Blystone
as most of you know we have the employment report this week

Dan_Blystone
given the volatile nature of the past week, this should be a particularly exciting number to watch and trade when it comes out on Friday : )

Dan_Blystone
lets take a closer look at the number for a minute

Dan_Blystone
mployment Report Importance: Highest. Published by: Bureau of Labor Statistics, U.S. Department of Labor. Frequency: Monthly. Release Time: First Friday of the month at 8:30 ET Coverage: Prior Month. Web: http://stats.bls.gov/news.release/empsit.toc.htm

Dan_Blystone
if you take a look at this page it tabulates the reaction of various markets (stocks, bonds the dollar etc) according to what the report tells us:

Dan_Blystone
http://traderslog.com/indicators-dollar.htm

Dan_Blystone
so you can see for example that as you might guess, a high unemplyment number will typically be bearish for the dollar

Dan_Blystone
payroll employment down also bearish for the dollar

Dan_Blystone
Next...

Dan_Blystone
going back to a question I had earlier, and this is one I get frequently, which is 'which currency pair should I trade?'

Dan_Blystone
here are some basic suggestions

Dan_Blystone
first of all you will want to look at the volatility of the various pairs and how much movement you like to see

Dan_Blystone
so taking the gbp/usd as an example, which gave us as I said a 500 pip move yesterday, would be suited to someone who likes and can handle a high degree of volatility

Dan_Blystone
or if you prefer a smaller range you could look at the eur/gbp with a very small range typically

Dan_Blystone
in short - you should try to get a feel for your trading personality when you are figuring out which pairs to focus on

Sue
<Q>Hi Dan Blystone, can you explain about LIBOR ( job descriptions)

Dan_Blystone
<A>Libor is the the London Interbank Offered Rate. The rate of interest at which banks borrow funds from other banks, in marketable size, in the London interbank market. LIBOR rates are disseminated by the British Bankers Association. Some interest rate futures contracts, including Eurodollar futures, are cash settled based on LIBOR.

henlie
<Q>dIIs it beter to lose money on say -50 pips than went into hedge?

Dan_Blystone
<A>I personally don't hedge my positions much - but as I mentioned earlier, using currency correlations can be useful for hedging strategies

Guest_crezus
<Q>what is the best use the Average True Range indicator

Dan_Blystone
<A>ATR is useful to indicate the strength of a trend - if it is trending upward the trend is getting stronger. Also see: http://www.traderslog.com/Average-True-Range.htm

Guest_libra02
<Q>can you use the currency relation ships to do some hedging

Dan_Blystone
<A>yes, absolutely Libra - it does take some skill as you have to be careful not to be caught wrong on both sides of the hedge

kjunnarkar
<Q>dan, do you check the fx futures to see where they are trading and do you still trade the fx futures market?

Dan_Blystone
<A>yes, I do keep an eye on the fx futures and I do like to trade the fx futures market. I recommend exploring the futures markets to all cash market traders

Guest_libra02
<Q>can you give me an example how to avoid that ????

Dan_Blystone
<A>I would check out Kathy Liens 'Day Trading the Currency Market' - it discusses currency correlation and hedging - a great book

Guest_libra02
<Q>fx futures do they give you any direction or indication as to which way market will be moving meaning the spot market

Dan_Blystone
<A>possibly -I think fx futures are good for trading during times of extreme volatility eg during the payrolls release, as you tend to get better execution than in the cash market

Beforex
<Q>Recently price action has gone opposite to expectation on news. Is this a nuance or result of the current market enviornment.

Dan_Blystone
<A>it is very difficult to predict the outcome of an economic release, because sometimes expected news will already be priced into the market - the best situation is when a number comes in way off expectation, that really gives you a clear idea of where the market is going to go - the challenge is then getting in quick enough

Guest_crezus
<Q>where can we find a list of pairs based on volatility and trading (trend or range)

Dan_Blystone
<A>GBP/USD, USD/CHF, GBP/JPY and GBP/CHF see the most volatility with average daily ranges of up to 140 pips.

Guest_crezus
<Q>where can we find a list of pairs based on volatility and trading (trend or range)

Dan_Blystone
<A> GBP/USD, USD/CHF, GBP/JPY and GBP/CHF see average daily ranges of 120 pips during the US trading session

Guest_crezus
<Q>where can we find a list of pairs based on volatility and trading (trend or range)

Dan_Blystone
<A> EUR/CHF, USD/SGD, EUR/GBP are the least volatile

Dan_Blystone
Thats all we have time for today - thank you call for attending and I hope to see you next week!

Moderator_FXstreet
Thats all we have time for Today .Thank you very much for that Dan!

Moderator_FXstreet
Thank you all for your participation. See you soon!