# Understanding Commodity Correlations

If you look at the average on a 5 minute chart versus an hourly chart, the number will vary yet again.

What are correlated currency pairs? These are just a few correlations examples between currency pairs or between currency pairs and other markets and they are pretty much valid these days as they were valid a few years ago as well.

Correlations can be measured Correlations between currency pairs are never perfect.

## What is correlation?

They both contain the same currency in the pair USD , which half weights them with the same instrument. You would expect both the Euro Zone and Switzerland to share a need for buying and selling US dollars. They need them for buying oil, importing and exporting to the US, etc. Anyone with a cursory understanding of macroeconomics could explain why this relationship makes sense.

Correlation traders typically settle on pairs that share a common currency. Assuming that the spread is not outrageous, it makes more sense to simply buy or sell EURCHF directly rather than going through the convoluted process of managing two open trades.

If you decide to pursue the two pair approach, you must consider the need to balance the trade sizes against each other. Unless you intentionally decided to trade different sizes, you may want to consider equalizing them. What correlation is not Correlation only provides insight into the probability of direction.

It says absolutely nothing about the strength of a particular move. You lost a ton of money. Regardless of what happened, correlation told you nothing about the outcome when they move in the same direction.

For that reason, I prefer looking at a less intuitive method called cointegration. Cointegration Conintegration turns the problem on its head.

Rather than asking whether or not two pairs move in the same direction, it asks how likely are they to remain a certain distance apart. Naturally, that distance tends to vary with time. What you want the cointegration formula to tell you is how likely two pairs are to come back to a standard distance. If you see two pairs spread unusually far apart and the numbers tell you that they usually come back together, then it makes sense to consider a pair trade.

Firstly, correlations between currency pairs are continually evolving. There is no guarantee that the relationship that was seen at the start will hold for long and in fact it can even reverse over certain time periods. For more reliable hedging strategies the use of options is needed. Using a collar strategy is a common way to hedge carry trades, and can sometimes yield a better return.

Selling covered options As an alternative to hedging you can sell covered call options. But as writer of the option you pocket the option premium and hope that it will expire worthless. Of course if the price falls too far you will lose on the underlying position. But the premium collected from continually writing covered calls can be substantial and more than enough to offset downside losses. Hedging with derivatives is an advanced strategy and should only be attempted if you fully understand what you are doing.

The next chapter examines hedging with options in more detail.

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Forex Correlation Matrix. Over the years, Forex strength meter has naturally evolved into a correlation matrix that could also be more complex and accurate. Forex Correlation, like other correlations, is a term designated to signal correlation between two of the pairs. When two sets of data are strongly linked together, we say they have a high correlation. Each cell of the table shows the correlation coefficient between the two currency pairs (vertical headings) over the corresponding time period (horizontal headings). The following categories indicate a quick way of interpreting the table values.