Hedging and Correlation – Chapter 12 | Learn Forex

Currency correlation:

Correlation indicates the relation between two mutually dependent variables at a certain time. In the forex world, it means how two currency pairs statistically move either in the same direction or in the opposite. Therefore correlation values can be either in positive or in negative between 0 to 1.

Correlation value can be calculated for any two securities, not necessarily only between currency pairs. Example, AUDUSD vs Gold

Currency correlation table
IQ Currency correlation table indicator for metatrader

Use of currency correlation in trading:

Correlation values are widely used in different kinds of trading, including hedging (explained later).


Example:

Suppose, if EURUSD vs USDCAD has a correlation value of 0.70 for the last 5 minutes. Then this can be denoted as 70% positively. Therefore, if during these time USDCAD moves 10 pips then EURUSD also has moved 7 pips (70% of 10 pips).

Hedging:

Hedging means having a buy and sell trade all together on the same securities or multiple securities that are correlated with each other and aggregating the total position value for profits or reducing the loss.

Hedging can be done by opening trade on the same currency pairs at the same price or different prices also in combination with other correlated currency pairs. Sometimes, hedging is used to fix the amount of loss (ignoring the swap charges)

Practical example:

Suppose a trader opened a buy and sell order at 1.2510. That means no matter what direction market moves, both buy and sell orders are hedged. The trader will see the commission or spread cost and swap fees. (One swap fee will be positive and one will be negative)

For loss reduction:

Suppose a trader has an open position at 1.2550 buy order is currently at 20 pips loss as the market has fallen to 1.2530. So If he has not set any stop-loss he could just open a sell order at 1.2530. It will hedge the position with 20 pips maximum loss.

Basket trading:

One of the popular trading strategies among traders where they open multiple orders in different correlated currency pairs for hedging the overall position.

In this way, the overall position will be less risky and will generate a stable profit.

The term basket is used here because orders are placed with one single base currency and its combination with other currencies. Below is an example with GBP basket:

Currency pair Trade Profit
GBPCHF BUY $0.52
EURGBP SELL $0.37
GBPJPY BUY $0.66
GBPCAD BUY $0.35
GBPNZD BUY $0.40
GBPAUD BUY $0.47
GBPUSD BUY $0.46

Total: $3.23 profit


NOTE:

EURGBP was in sell position due to EUR negative correlation with GBP.

Forex School

Train yourself to be the best forex trader with premium forex lessons.

Forex Decentralized Market – Chapter 4 | Learn Forex

Forex Decentralized Market – Chapter 4 | Learn Forex

The term decentralized means something which does not get controlled from a central organization. Or a department that moves away from a central location to other location and operates independently. The benefit of a decentralized system is, it reduces workloads from the main center. The financial market has two categories in terms of its organizational […]

Forex Market Liquidity – Chapter 2 | Learn Forex

Forex Market Liquidity – Chapter 2 | Learn Forex

What is Forex Market Liquidity? In the financial realm, liquidity represents ‘how easy it is to buy or sell your shares, contracts, or, in this case, currencies’. In simple terms, suppose one needs to buy some Euro with the US Dollar. Then, (s)he needs someone in the market who would buy his/her US dollar & […]

Forex Leverage – Margin – Chapter 9 | Learn Forex

Forex Leverage – Margin – Chapter 9 | Learn Forex

Lotsize or Position Size The lot size is the amount or the trade volume unit. How much money a trader will invest in trading a currency pair or instrument. More clearly, the number of currency units traders will buy or sell. The table below explains the details of forex trading units. Lot Size Lot Size […]

Latest posts

Check all recently updated & newly posted forex articles, forex trade analysis, MetaTrader indicator manual update.

Contact – IntraQuotes

Contact – IntraQuotes

Last updated on September 9, 2020

About

About

Last updated on September 8, 2020

Subscribe
Notify of
guest

This site uses Akismet to reduce spam. Learn how your comment data is processed.

0 Comments
Inline Feedbacks
View all comments
0
Would love your thoughts, please comment.x
()
x