In this very brief post, I plan on illustrating one concept…and one concept only: the notion that if you are not employing currency correlation in your trading strategy, you are drastically increasing your risk. We’ll start with a model I have crafted, the DML model. It’s quite simple really, and brings nothing new to the realm of forex, but it does provide a good idea of what influences profits on the Forex. The DML model is as follows:

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P(Profit)=D(Direction)*M(Magnitude)*L(Lot Size)
This is the way most traders, and especially noobs, go about their trading; that is, linearly. A trader would, say, go long on a single currency pair (EURUSD for example), and hope that it goes up. Yes, you can analyze the fundamental and technical side of your trade before you enter the actual order…but let’s face it, anything can happen--if you think otherwise, kindly state your reasoning so that myself, and others on this forum, can clarify your misunderstanding. The problem with this linear model is that there are three variables that influence profit--really one, two are limiting factors to your potential profit level. Direction determines where or not you WILL make a profit…while magnitude and lot size determine what that profit will be. If you rework the raw DML formula however by adding another currency pair, one that is highly correlated, it looks like this:
P=D0*M0*L0 + D1*M1*L1
What you’ve done, if you’ve employed a highly correlated pair, is virtually eliminated the risk from direction. While direction still impacts your trade, because the pairs are highly correlated, you have succeeded in synthetically taking away an unnecessary element of risk in your trading.
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