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This week we will explore a couple more interesting things about forex correlations. How would you like to be able to double check a breakout past supply or a breakdown past demand?
Occasionally we might notice that a break is quickly retraced and the move reverses. WHY fake breaks happen is for the conspiracy theorists out there; just understand that they do happen. So, how could we use correlations to determine if the break is real or not?
The horizontal lines mark the low price lines, while the first vertical line marks when they were all lined up. However, in this instance they would have been quickly stopped out. Understanding the correlations between these three currency pairs would have kept the more knowledgeable trader from taking the short trade. Here is the thought process. A slightly more aggressive trader will still take the short trade, but perhaps trade a smaller position size.
With vertical line marked 1, each currency pair had hit a high and retraced. However, both other currencies with such a high correlation! Both have already broken past their previous highs and were trending higher-perhaps think of it as those two are dragging the USDJPY after them.
As far as an Online Trading Academy core strategy play, how could you use this information? When the other pairs break to the upside, look for a quality demand zone to go long the lagging pair. On the flip side, when the other pairs break to the downside look for a quality supply zone to short the lagging pair.
One last tidbit on using these charts, imagine your currency pair is approaching your profit target. What might you consider doing if the other, correlated pairs were still running in your direction? Could they keep dragging your trade even past your profit target? Would moving your profit target even further out make sense? That is certainly possible.
Learning how to manage your winning trades as their correlated pairs are still running can definitely put more pips in your pocket! Please also understand that the correlations between currency pairs can and do change.
However, when measured over the past month their correlation has dropped to a -. One must not rely on unreliable data when using correlations! There are many resources on the internet as far as how to calculate these correlations, plus many of your platforms will offer them as indicators. Please check the correlation figures and make sure they are compatible with the time frames that you plan on trading. Nor would I use a high one day correlation if I were planning on a long term position trade.
So there you have it, traders! Use the correlations to help confirm if a breakout is real or not, and also help to manage your winning trades.
As the correlations change over time, keep in mind that what worked last year might not work this year. Disclaimer This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader.
The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein.
Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.