The following is our monthly correlations update for November. As we have mentioned time 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 the 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 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 EURUSD and USDCHF is different than having a portfolio comprised of EURUSD and GBPUSD. As indicated in the tables below, over the past month, the EURUSD has had a strong negative correlation (-0.95) with the USDCHF and a strong positive correlation with GBPUSD (+0.82). Therefore having a long EURUSD and long USDCHF exposure would generally lead to negated or nearly zero profit or loss because when the EURUSD rallies, USDCHF will sell off the majority of the time. Of course, these two currencies may have different pip values and the correlation is not perfect, so the P/L may not be exactly zero. On the other hand, holding long EURUSD and long GPBUSD exposures would be similar to nearly doubling up in one of the pairs since the correlation is so strong. Furthermore, we can tell from our tables that correlations shift with time. From the commodity bloc for example, the AUDUSD has proven only a modest positive correlation to the NZDUSD (+0.46) over the past three months. When looking back only over this past month, however, this relationship has developed markedly (+0.82). 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.
FX Correlations (data as of 12/01/06)
