A trading technique is not always just a set of indicators. Let’s explore its performance on the EUR/USD and GBP/USD currency pairs. In case you like the algorithm, you can extrapolate the said algorithm to other financial instruments.
Correlation in trading
Correlation is a statistical interdependence between two directly unconnected values. At any given moment in time the EUR currency rate does not depend on the GBP currency rate, however they have a distinct mutual connection if we take a deeper look at the historic data.
The average level of correlation of currency pairs was calculated a long time ago, all currency pairs can be presented in a correlation table. The quotient of correlation can be seen in the table. The closer the value of the quotient to 1 and -1, the higher the correlation.
The same goes for other currency pairs. The picture illustrates the correlation between the frank and the euro in relation to the Japanese yen. In the left part of the picture the charts are practically identical.
If we take a deeper look at the main currency pairs and present them as a fraction, all of them usually have one common denominator – American dollar (USD). The gradation of the level of liquidity of currency pairs would be approximately as follows (USD is used as the reference system): Euro – Pound – Swiss Franc – Yen etc.
Euro, franc and pound are in circulation within the same continent, earlier they were part of a single economic union. No special instruments are necessary to draw the conclusion that currency pairs correlate to a certain extent.
We will trade 1-minute GBP turbo options using the Euro as the main signal (the lead currency pair).
We can also monitor the CHF in case we don’t have enough transaction, but in that case the currency pair is reversed (USD the numerator), therefore it is not always convenient.
Correlation in trading turbo options
The strategy is quite simple: if the Euro currency rate grows, the GBP currency rate falls – we buy GBP, and vice versa. In case the decline of the Euro coincides with the GBP growth, we should sell GBP.
It is preferable to use a 5-minute time frame, but for now we will choose 1-minute turbo options.
Let’s combine both charts and see what we have.
Only two sections are highlighted in the chart, but you can see that the colours of the candles in the charts are quite frequently different. The trading technique is based on the fact that the lead pair (EUR/USD) gives an impetus to the whole market, therefore all other currency pairs will be inclined to correlating with this currency pair.
The EUR/USD currency pair is the lead pair, we DO NOT CONDUCT TRADE with this pair, we just observe. The GBP/USD currency pair is the driven currency pair; we conduct trade with this pair only. We open trade when:
- The GBP/USD correlation is ascensive (rising): the candle of the EUR/USD currency pair is positive (upwards), the candle of the GBP/USD currency pair is negative (downwards).
- The GBP/USD correlation is descending (falling): the candle of the EUR/USD currency pair is negative (downwards), the candle of the GBP/USD currency pair is positive (upwards).
Peculiarities of the trading technique
1. We should conduct trade only during an active trade-session. In case it is yet too complicated for you, based on your experience, to distinguish between active periods, you can set the indicator, which measures the volatility at the current point of the market, for example Awesome indicator.
If you extrapolate the bar chart and visually determine the deviations of the columns during active sessions (this is easy to spot if you compare data from the bar char with deviations of the deviations of the candles of quotes) you will see and later you will memorize the approximate time when the market is rather active.
2. Say NO to multiple techniques. A scalper selects his financial instrument very thoroughly and meticulously, like a good violinist picks his violin. Do not rush. A don’t even think about employing multiple tools at the same times. You simply won’t have enough time and attention for all of them. You will lose more, than you will gain. Remember, that the 6 to 4 proportion of profitable and unprofitable transactions is a great achievement for a scalper. If you embark upon the constant search of a perfect instrument hoping to gain profits, you will lose time and money.
3. You shouldn’t take into consideration a certain correlation value, because it may not be in favor of the selected currency pair. However, it is absolutely necessary to maintain absolute homogeneity – currency to currency, but not with metals, though gold and silver are traded for USD and are basically a pair. The same goes for oil. Besides homogeneity – it is necessary to use the algorithm as it was illustrated – we should determine the volumes. I.e. if we take metals, it is good to trade gold and silver according to the same algorithm, but you should trade anything else of this line of metals, due to a weak connection it will be fairly difficult to choose the lead asset.Practice for free
NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future
GENERAL RISK WARNING
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.
76% of retail investor accounts lose money when trading CFDs.
You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.