The following is our monthly correlations update for September. 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 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 GBPUSD is different than having a portfolio comprised of EURUSD and USDCHF. As indicated in the tables below, over the past month, the EURUSD has had a relatively strong positive correlation (+0.66) with the GBPUSD and a strong negative correlation with USDCHF (-0.85). 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 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 GBPUSD 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. For example, the AUDUSD pair has historically held a relatively strong positive correlation with the NZDUSD (0.68) over the past year. Just this past month, however, this relationship has eroded rather markedly(+0.26). 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 10/02/06)
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