One of the most interesting things about any financial market is its correlation with one another. As a forex trader, it is paramount that you understand that forex is about currencies, and also that a currency can correlate with another financial product.
Finding Correlations
A correlation exists when two financial markets move at the same time. A correlation can be both a positive correlation, or a negative correlation. When two markets showcase a positive correlation, they move in the same direction, up or down. When two markets are negatively correlated, they move in different directions, one up and one down.
Correlations may occur for any number of reasons:
- Sentiment – The sentimental correlation is one which results from our preconceived notions about a certain financial product and a currency. Gold and the US dollar share a very strong sentimental correlation, which we’ll explain in a later article in this series.
- Institutional Correlations – Some correlations result from economic institutions. When we discuss economic institutions, we don’t mean major banks. Instead, we’re talking about economic systems that create a certain structure. For example: the US dollar and oil share a negative correlation. This is because of the economic institutions that require oil to be traded only for US dollars.
- Risk – Risk is a very important part of any financial market. When investors are feeling more confident, they may take on more risk and buy up two correlating financial products at the same time. When investors feel less confident, they accept less risk. Risk-profile is especially important in the bond markets, which are also important to the currency markets.
In the next few articles, we’ll explain how these correlations exist, and why they exist. We’ll start first with commodities, oil and gold specifically, and how these commodities correlate with certain currencies and currency pairs.
