Each currency pair actually is a combination of two currencies. So if you are short in GBP/USD then you are in fact selling the GBP and buying the USD. In each of the four major currency pairs, USD is part of each currency pair. Download these Correlation Trading Cheatsheets FREE. Get this 1 Minute Forex Trading System FREE that makes money instantly anytime you want! Learn this powerful Fibonacci Retracement method FREE that pulls 500+ pips per trade!
This means that you should study and understand the fundamentals of US Dollar, the US economy and the workings of the Federal Reserve System (FED). Then you have done your homework needed to trade any one of the four major currency pairs as all of them depend on USD.
What do you think; USD will weaken or strengthen in the near and medium term? The only thing you need to determine is your bias for USD before each trade. Off course develop a system that guides you in forming an educated bias. Then apply that bias to the major currency pairs.
One bias, four trades! But each currency pair will react differently to USD. For example, if Euro is also strengthening. The currency pair EUR/USD will move less with USD also strengthening as compared to USD/JPY if JPY is weakening.
You should always evaluate the currency correlations for the major currency pairs in every trading plan that you create. Correlation is determined by what is known as the correlation coefficient. Correlation coefficient always ranges between +1 and -1. The correlations between the currency pairs are dynamic and can change any time. So you need to calculate the correlations at least on weekly basis to give you a fair idea of how the correlations are changing.
USD/CHF and EUR/USD have a correlation coefficient of -0.975. This is pretty close to -1. It means both these pairs move in the opposite direction almost all the time. To be precise 97.5% of the time if USD/CHF moves up, the pair EUR/USD will move down!
You have this information. It tells you how much these pairs move in the same or opposite directions. Suppose you trade both the pairs USD/CHF and EUR/USD by going long at the same time. What you will be doing is in fact canceling both the positions.
However, you notice on the charts that the other three major currency pairs are not showing volatility and moving as much as the GBP/USD. EUR/USD is not showing volatility and moving up on the chart. USD/CHF is not showing much volatility and moving down on the chart. USD/JPY is also not showing much volatility and not moving down on the chart. This means that the volatility in GBP/USD is solely GBP driven. The move is maybe related to some news in the British economy about Bank of England raising or lowering interest rates or some big companies merging.
Take another example. Suppose you have entered a short EUR/USD trade. You want to know whether the pair will either proceed down towards your profit target or go against you and cause you to exit the trade with a small loss.
Your EUR/USD is heading towards M1 level after having broken the S1 support pivot level. You should take a look at the pair EUR/GBP. You find that it has paused at its S1 support pivot level. It is showing signs of reversing to the upside.
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