Forex Correlations: The Eurozone Perspective And Impacts
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There are over 180 currencies today recognized as official legal tenders in different countries. The global foreign exchange market provides a way to exchange monetary value between other currencies, ensuring worldwide trade and economic continuity. But the value of currencies in the forex market is affected by several factors, chiefly the economic conditions of countries. And because all currencies are linked in the forex market, they invariably impact each other, with some having more impact than others.
For example, if you use TradingView for forex trading, you’d notice the ever-changing prices on currency pairs. You’ll also see that some currencies tend to mirror the price direction of others, while some seem to always move in the opposite direction. This is called currency correlation in forex and is an essential point in technical analysis.
What is currency correlation?
Currency correlation, defined in the context of financial trading, is how the price of two currency pairs move about each other, measured over some time. Currency correlation provides data on two currency pairs’ positive, negative, or neutral relationship. Positive correlation occurs when two forex pairs move in the same direction in the same period, while negative correlation occurs when the movement is in opposite directions. Neutral correlation is more common when currency pairs’ prices move randomly without correlation.
There’s also something called the correlation coefficient, which is a numerical representation of the positive (+1), negative (-1), and neutral (0) correlation.
Why is forex correlation possible?
Close economic ties and geographical proximity are two important factors that influence the correlation of currencies in the forex market. For instance, currency pairs with the GBP and the EUR may have a strong correlation due to the UK's and Europe's geographical proximity. The economic ties between the Eurozone and the UK (Britain only recently exited the EU) also make it possible for the EUR and GBP pairs to correlate.
Another example is the positive correlation between GBP/USD and EUR/USD. Both pairs typically move in the same direction always. On the other hand, the USD/JPY and EUR/USD pairs are negatively correlated, so they move in opposite directions.
Since the exchange rates of currencies constantly change, the factors affecting the economy and the exchange rate also impact correlated currencies. Studying the European Union's economic perspective is crucial to trading currency correlations in forex.
The Eurozone: economy and monetary policies
Europe is one of the biggest economies, having 27 member states and a combined GDP of over $11 trillion. As one of the major economic powers, the EU oversees the Euro (EUR) through monetary policies and regulations by the European Central Bank (ECB), cooperating with its member nations. The EU also has close economic and political ties with countries like Britain, the US, and Canada. International trade with other countries is a significant economic activity in the EU. Experts forecast key economic growth in 2023 for the EU.
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The EU monetary policy aims to keep the inflation rate at a healthy 2% inflation rate and keep the economy excellent for a strong EUR exchange rate. The EUR remains the second most-traded currency in the forex market, with an average daily trading volume reaching 40% of the total forex market volume. Thus, all currency pairs with EUR are essential and are impacted by its exchange rate.
Currency correlations: perspective of the Euro
The EUR, USD, and GBP are closely related, and their pairs are highly correlated. For example, the EUR/USD has an average daily trading volume of over $560 billion. At a 0.7 correlation coefficient with the USD, EUR pairs typically go in the opposite direction with USD pairs. If inflation affects the exchange rate of the EUR, traders will find that the USD pairs also change, taking a different direction from the former.
The GBP also correlates at 0.6 with the EUR. With an average daily trading volume of over $60 billion, the EUR/GBP pair holds a fair percentage of the forex market. That’s why significant changes in exchange rates impact the GBP pairs. So, for example, the GBP/USD pair goes up when the EUR/GBP pair goes down.
This is perhaps best seen in the EUR’s recent surge and the USD’s plunge following the ECB’s monetary policy announcement. The impact of current events, such as the energy crisis towards the end of 2022, the situation in Ukraine, and inflation, also affected the EUR and USD exchange rates.
Trading currency correlations
Studying currency correlations in technical analysis helps traders understand the market and increases their accuracy in predicting prices. Here’s how to trade correlating currency pairs:
- Choose the pairs you prefer: It is best to focus on one or two currency pairs at a time so that you can analyze their price charts. Check the correlation coefficient for each pair to determine your exposure.
- Plan your entry and exit points. Calculate the lot size and expected profits.
- Use indicators, SL, and TP to maximize your trade. Remember to use proper management techniques.
Trading forex correlations give traders an advantage in making analysis easier. When trading the EUR and correlated pairs, you must check the movement of other currencies, such as the USD, JPY, and GBP, as these currencies also correlate with the EUR and affect its exchange rate.
Ensure your trading plan accommodates sudden changes, as news of events often impacts the market. You should also look out for the trading volume. The EUR pairs often see more activity when the London (European) trading session opens (London Open – 8:00 AM local time, 2:00 AM EST, and 7:00 AM UTC. But overlapping sessions such as the New York Session may also impact the EUR due to an increased USD trading volume.
Start trading today and leverage the EUR correlation to analyze the market.
