How do you counter correlation risk?

Hello. After two weeks of testing my strategy, I’m beginning to see a pattern. My trades either all result as winners, or all result as losers, and all at the same time. This is most likely because I trade four pairs, and all of them rely on USD. Since I don’t mind having two or even three trades open at the same time, I end up opening the same position three times in slighly different, but highly correlated, charts.

I’ve thoughts of a way to combat this, and I’d love some input.

Trade 12 pairs instead of 4.

Divide them into three groups of 3 pairs.

Each group would be exposed to the same currency. For example, AUDUSD, GBPUSD, USDCAD and EURUSD would be the USD group, and is currently all I’m trading now.

These groups would depend on the three largest currencies: EUR, USD and JPY.

I will only have up to three trades open at the same time, and only one trade per group.

I don’t know if this makes sense.

I think I get you. you want to select one pair from separate baskets containing correlated pairs. So each basket has pairs that are highly correlated with each other, but with low correlation to the pairs in other baskets.

Okay well maybe that’s it maybe not. There is a lot of interest in risk diversification through correlation at the moment. I would suggest you use a correlation table or matrix to check how prospect trades correlate with currently open positions so that the inter correlation between all positions is within a range, say -0.35 < x < 0.35.

It is similar to what you are trying to do but easier. One reason the above may be cumbersome is that the interdependence of pairs changes over time. so once you have a basket with seemingly correlated/uncorrelated pairs you would have to check them continuously to make sure they retain the same properties.

Consider this:

  1. no open trades - good signal arrives - enter trade
  2. 1 open trade - good signal arrives - check correlation with existing position, if in range - enter trade

and so on.

Correlation risk is absent since efficient market eliminate such trading opportunities. You’d better sort out pairs based on their recent volatility (year, month, week) and use this approach as volatility metrics are different and provide data with different approximation. It’s the trading field where you can gain edge