The following is our monthly correlations update for August. As we have mentioned again and again before, correlations between different currency pairs will inevitably shift over time, therefore it is of utmost importance to keep abreast of these changes. Below are the one-, three-, six- and twelve-month correlations for seven major currency pairs. Additionally, we have included the six-month trailing correlation versus the EURUSD as further confirmation of the correlation.
In order to be an effective trader, it is also important to understand how different currency pairs move in relation to each other. There are a few reasons why this is significant, but most importantly, it allows traders to understand their exposure. That is, having a portfolio that consists of the USDJPY and NZDUSD is different than having a portfolio comprised of USDJPY and USDCAD. As indicated in the tables below, over the past month, the USDJPY has had a strong positive correlation (+0.78) with the NZDUSD and a strongly negative correlation with USDCAD (-0.79). Therefore having a long USDJPY and long USDCAD exposure would generally lead to negated or nearly zero profit or loss because when the USDJPY rallies, USDCAD will sell off the majority of the time. Of course, these two currencies have different pip values and the correlation is not exactly 1.0, so the P/L may not be exactly zero. On the other hand, holding long USDJPY and long NZDUSD exposures would be similar to doubling up on the position since the correlation is so strong. Furthermore, we can tell from our tables that correlations shift with time. For example, the USDJPY pair has historically held little relavant correlation with the NZDUSD (-0.05) over the past six-month period. Just this last month, however, this relationship has become much more statistically relavant (+0.78). Shifts such as these can be partially explained by changes in the severity of monetary policy or changes in unique domestic conditions. Overall, having this knowledge will allow traders to effectively diversify and manage their portfolios.
Regardless of your trading strategy and whether you are looking to diversify your positions or find alternate pairs to leverage your view, it is very important to keep in mind the correlation between various currency pairs and their shifting trends.
