The following is our monthly correlations update for February. As we have stated time and again, correlations between different currency pairs will inevitably shift over time. Therefore, it is of utmost importance to keep abreast of these fluctuating relationships to fully understand your trades and portfolio. Below are the one-, three-, six- and twelve-month correlations for the seven major currency pairs. Additionally, we have included the six-month trailing correlation versus the EURUSD as further confirmation of the correlation.
In order to be an effective trader, it is important to understand how different currency pairs move in relation to each other. There are a few reasons why this is significant, but most importantly, it allows traders to understand their exposure. For example, having a portfolio that consists of the USDCHF and EURUSD is different than having a portfolio comprised of USDCHF and USDJPY. As indicated in the tables below, over the past month, USDCHF has had a strong negative correlation (-0.80) with USDJPY and a relatively high positive correlation to EURUSD (+0.81). Therefore having long USDCHF and long EURUSD exposure would generally negate profit or loss because when EURUSD rallies, USDCHF will sell off the majority of the time. Of course, these two currencies may have different pip values and the correlation is not perfect, so the P/L will not be exactly zero. On the other hand, holding long USDCHF and long USDJPY positions would be similar to nearly doubling up in one of the pairs since the correlation is so strong. Furthermore, we can tell from our tables that correlations shift with time. Holding to our previously example we can see, USDCHF had only a ‘modest’ correlation with USDJPY (+0.49) over the past year. However, just this past month, as risk aversion tides rose, that positive relationship has tightened significantly (+0.81). Shifts such as these can be partially explained by changes in the severity of monetary policy or changes in unique domestic conditions. Overall, having this knowledge will allow traders to effectively diversify and manage their portfolios.
Regardless of your trading strategy and whether you are looking to diversify your positions or find alternate pairs to leverage your view, it is very important to keep in mind the correlation between various currency pairs and their shifting trends.
FX Correlations (data as of 03/03/08)
