FXstreet.com Live Sessions Archives: Forex Trading Correlations

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

Dan_Blystone
Good morning from Chicago, and welcome to this week's session!

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

Dan_Blystone
Right - let's get started with today's topic - using corellations in your forex trading

Dan_Blystone
we'll begin by talking about the relationship between commodities and 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.

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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.

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Gold and it's relationship to the Forex Market

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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.

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This is because during periods of geopolitical uncertainty traders tend to migrate away from the US Dollar and towards gold as a safe haven.

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In the world of Forex, no major currency is considered to be as safe and stable as the Swiss Franc.

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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.

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For these reasons the CHF/USD has a strong positive correlation with gold prices.

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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.

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Oil and it's relationship to the Forex Market

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

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

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

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The US imports 85% of Canada's oil exports.

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Rising oil prices have in part caused the Canadian dollar to rise to a 28 year high against the US dollar.

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now lets take a look at the correlations between the currency pairs themselves

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

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Correlation analysis helps you understand these relationships.

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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.

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

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Conversely - the closer the number is to -1 the stronger the negative correlation.

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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.

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Correlations can help a forex trader manage their risk exposure - by using a pair with a negative correlation as a hedge.

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A positive correlation between two currency pairs can be used as a leading indicator.

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you can keep track of correlations of currencies over different time frames here:

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

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now, I'd like to open up the floor for the q&a part of our session

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so please feel free to ask any questions you may have- don't worry if they are not specific to the material we just covered : )

denkir
<Q>Dan, could you explain the correlation between usdchf, usdjpy and the cross chfjpy? If the former 2 are carry trade currencies, why then the cross chfjpy is @ the historical high? Thanx

Dan_Blystone
<A>as you mentioned we should understand that the Yen and the Swiss Franc have been the main funding currencies due to their low interest rates.

denkir
<Q>Dan, could you explain the correlation between usdchf, usdjpy and the cross chfjpy? If the former 2 are carry trade currencies, why then the cross chfjpy is @ the historical high? Thanx

Dan_Blystone
<A>to go over the carry trade: The differences between interest rates of countries is what creates this opportunity. Countries who are experiencing economic growth will offer higher rates of interest. However, with the higher interest rates comes risk - there is no guarantee that the country's economy will be able to pay the interest on it's currency. For example if the Japanese Yen offers an interest rate of 0.25% and the New Zealand dollar offers an interest rate of 6.25%, some one selling the Yen and buying the New Zealand dollar can earn a profit of 6% as long as the exchange rate between the New Zealand dollar and yen remain unchanged.

denkir
<Q>Dan, could you explain the correlation between usdchf, usdjpy and the cross chfjpy? If the former 2 are carry trade currencies, why then the cross chfjpy is @ the historical high? Thanx

Dan_Blystone
<A>what we have been witnessing recently is the unwinding of the Yen carry trade, and this has had a ripple effect across the financial markets

Guest_Maher
<Q>which currencies move up more when the oil prices mak an upward move ? the CADJPY or the CADUSD?

Dan_Blystone
<A>interesting question - probably cad/jpy- but this would be a good one to tabulate the corellations for as on mataf.net

Guest_Maher
<Q>which currencies move up more when the oil prices mak an upward move ? the CADJPY or the CADUSD?

Dan_Blystone
<A>Kathy Liens book explains how you can set up the correlation tables in excel in her book 'day trading the forex market'

goncalo
<Q>should we use same time charts in gold for instance when we wish to correlate it with usdchf for instance?

Dan_Blystone
<A>yes, I would follow the same time charts in both financial instruments

denkir
<Q>Dan, we know that the eurusd and usdchf are often negatively correlated. What's the use of that if the pairs move without lagging each other?

Dan_Blystone
<A>you should be looking for a major move in one or the other - if you can move fast enough you will be able to catch the corresponding move in the other currency pair

Guest_Maher
<Q>what is the risk of carry trade? if a country offers high interest rate that indicate bad growth to the said country

Dan_Blystone
<A>you always risk the value of the base currency going down - it's no good making the interest rate differential if this happens!

Trend-MSTR
<Q>Thanks Dan, could we use GBP/USD as Gold index and USD/CAD as Oil index ?

Dan_Blystone
<A>hi Trend-MSTR - remember the AUD/USD has the most important correlation with gold

Okietrader
<Q>How much lag time is there between oil going down and the USD strengthening agaisnt the CAD?

Dan_Blystone
<A>depends on how dramatic the move is - if there is a big move in oil, there will likely be a very quick response in the CAD -

Guest_Maher
<Q>Do U recommend carry trade positions?

Dan_Blystone
<A>no, not really - more of an appropriate play for large institutional traders -

Guest_Maher
<Q>Do U recommend carry trade positions?

Dan_Blystone
<A>I personally think the best strategy for an indicidual fx trader going through a retail fx dealer is to try to exploit the great ranges you have in pairs such as the gbp/usd

Guest_Maher
<Q>Do U recommend carry trade positions?

Dan_Blystone
<A>personally I don't aim for catching anything less than a 30 pip move, and hopefully alot more than that

Guest_Maher
<Q>Do U recommend carry trade positions?

Dan_Blystone
<A>I don't think you can realistically scalp the cash fx market - due to the spreads and somewhat limited execution capability

Guest_Maher
<Q>Do U recommend carry trade positions?

Dan_Blystone
<A>but I think you can still successfully do intra day 'position trading'

Guest_Maher
<Q>Do U recommend carry trade positions?

Dan_Blystone
<A>the fantastic volatility and the leverage offered are what makes this market appealing to me

Dan_Blystone
for scalping - ie getting in and out of trades within seconds - I would open an fx futures account

almazz
<Q>What effect do you think the start up of the CME FXmarket will have?

Dan_Blystone
<A>I hope it works - they have reuters as a partner in this - the question is whether they will be able to provide the liquidity - the banks will still trade on the interbank market - I am excited about it and would love to trade the cash fx market on globex, just like the emini s&p

Guest_Maher
<Q>what i have noticed through my short experience in forex, that when the gold make an upward move, we notice the gbpusd make sharp upward move too , do you confirm such notice?

Dan_Blystone
<A>good observation Maher - this is likely due to the fact that the GBP is somewhat tied to oil prices and they do have significant oil reserves in the north sea

Guest_Maher
<Q>Dan , is there a hidden financial institutional power play with forex as well as stocks market? most of time i used to ask myself who moves the market most of time, !!

Dan_Blystone
<A>I think this is why it is so important to keep an eye on fundamentals

Guest_Maher
<Q>Dan , is there a hidden financial institutional power play with forex as well as stocks market? most of time i used to ask myself who moves the market most of time, !!

Dan_Blystone
<A>the big players that really move the markets are the major institutions, banks and governments

Guest_Maher
<Q>Dan , is there a hidden financial institutional power play with forex as well as stocks market? most of time i used to ask myself who moves the market most of time, !!

Dan_Blystone
<A>if you consider for example that many central banks are shifting their reserves over to the EUR, this explains the major upmove in that currency