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Currency pairs are interrelated in the forex markets. As a forex trader, understand that the price action of each currency pair is not independent of other.

Currency pairs are interrelated in the forex markets. As a forex trader, understand that the price action of each currency pair is not independent of other.

Most pairs move relative to one another. Understanding that different currency pairs are correlated is important for you. These correlation numbers can be positive or negative.

Knowing how strong this relationship is and its direction can help you a lot in developing your trading strategies. Correlation analysis has the potential to become a great trading tool for you.

Correlations are numbers that range between +1 and -1. These numbers are calculated based on past pricing data between different currency pairs. They can provide you with information that can maximize returns, minimize risk and avoid counter productive trading.

Lets make it clear with an example. Suppose USD/JPY and USD/CHF had a positive correlation of +0.83 last month. This number is close to +1 and means that both pairs are moving together most of the time in the same direction.

Now, if you are trading USDJPY and USDCHF at the same time, it will double up your position if you take long positions or short positions on both at the same time. If you lose a trade on USDJPY, the chances are that you will also lose the trade on USDCHF 83% of the times.

Lets take another example. EUR/USD and USD/CHF both have a negative correlation of -0.9 in the last month. It means both the pairs were moving in opposite directions last month. If you take long position on one, it is not a good strategy to take short position on the other. It will only double up your position again and increase risk.

While investing in two currency pairs simultaneously, try to choose such pairs that have correlations close to zero. Zero correlation means the two pairs are almost independent of each other and mutually exclusive.

Always keep this in mind that currency markets are constantly changing. The correlation between currency pairs also keep on changing. It would be a good idea to calculate the correlations between pairs on a monthly basis.