What is Currency Correlation?
1. Positive correlation is when two or more pairs trade in the same direction at the same time. For example when EUR/USD is trading up GBP/USD is also trading up.
2. Negative correlation is when two or more pairs trade in opposite directions at the same time. For example when EUR/USD is trading up the US Dollar Index is trading down.
How Can Currency Correlation Help Us Trade Profitably?
Since we know a pair is positively/negatively correlated with another we can look for hints the market leaves behind before a move happens. Woah no way???
What are these hints?
If a pair is positively correlated with another both should be making higher highs or lower lows at the same time. For example view the 4H chart below comparing EUR/USD and GBP/USD
http://i1083.photobucket.com/albums/...ps249fd2f8.png
Each higher high or lower low is happening at the same time stamp!
Knowing this one must ask him/her self what happens when one currency pair fails to follow the above pattern. For example lets say GBP/USD makes a higher high while EUR/USD makes a lower high. This is defined as a crack in correlation or falling out of correlation. Whichever you prefer. Please view the chart below demonstrating how this looks.
http://i1083.photobucket.com/albums/...ps4195dbd1.png
This is exactly the type of situation we are looking for. When two positively correlated pairs fall out of correlation at a major support or resistance level we can expect a reversal. This reversal may be as small as 25 pips but more often than not it results in larger moves. For example today's price action below.
http://i1083.photobucket.com/albums/...pse6c87c22.png
Don't expect 250 pips every time! As stated above the resulting moves can be as small as 25 pips but more often then not 50-100 can be expected. Again I must reiterate this method is to be used in conjunction with major support and resistance levels such as Big Figures and Mid Fgirues for example 1.3500, 1.3550, or in this case 1.3000. Of course it doesn't have to happen at a mid/big figure the only requirement is that it does happen at a major support level such as a daily or 4H.
Negative Correlation
Negative correlation is when two related price units trade in opposite directions at the same time. When EUR/USD makes higher highs the US Dollar Index forms lower lows. Example below
http://i1083.photobucket.com/albums/...ps2c5966c9.png
We can look for a crack in correlation such as E/U making higher highs while USDX fails to from lower lows. Example below
http://i1083.photobucket.com/albums/...ps994388c5.png
Examples with the help of NetDania Charts since Oanda mt4 doesn't offer USD Index.
If you'd like to try NetDania charts follow the steps below.
1. Open NetDania Charts
2. Right click chart > New > Choose instrument
3. Right click chart > Overlay > Second instrument
How the heck do we trade this???
Note: Long term signals are more reliable than short term. 1m is useless. 5m will has more losses than 15m. This isn't to say not to trade the 5m chart though it can be profitable if you trail stops to break even +10 quickly. Most 5m signals are good for 10-20 pips and sometimes it's possible to catch the daily high/low reversal for 60 to 100+. 4H and Daily will provide the most pips but these trades can take weeks/months to reach profit targets. Best case scenario would be to find a 1D+ divergence and 1h divergence forming at the same time @ a major s/r level like 1.3000. This doesn't happen vary often but when it does price explodes.
Click here for step by step trade example
Here are a few options.
Important - Always wait till the diverging bar has closed. For example if a 15M divergence appears on the current candle do not trade till the current candle has closed.
1. Wait for a bar to close in the direction of the divergence signal. Example. E/U makes a higher high G/U doesn't the next few bars happen to be doji's or small greens and finally a bar closes to the sell side. Enter at the close of this bar as long as the divergence is still valid.
2. Trade your favorite system. Look for a signal in the opposite direction of the current trend. <- Scalping systems might get a signal for 15M divergence entry?
3. Wait for a retest of the divergence candle high/low.
4. Set a limit order and wait for the breakout to occur <- Maybe the best option for newbies?
5. Combine 1, 3, and 4 - If when price reverses the risk is vary small enter. If the risk is a little to much for your liking at the next up/down bar wait for a retest of the diverging swing high/low. If price fails to retest set a limit order to breakout trade.
Stoploss
Stops should be set to the most recent swing high/low or x number of pips above/below the swing. In the example below a stop loss would be placed at or above the divergence swing or the most recent swing high depending on when you got into the trade.
Take Protfit
Profit points can be figured a number of ways. I like Fibonacci extensions (swing projection) 1.272, 1.618, 2.0 and 2.618. In extreme cases 4.236 extension will be my last target where all remaining profit is taken. Also note how price acted within these Fibonacci extensions yesterday price ranged between 1.272 and 1.618, stalled around 200% and traded within 6 pips of 2.618 before the market closed for the weekend.
http://i1083.photobucket.com/albums/...psbf0664f3.png
Please note - I (and many others) were taught how to trade this method by mentor Michael Huddleston. My only goal here is to teach you a vary simple and profitable method of trading. If for whatever reason you decide this can't possibly be true please go elsewhere and trade another method.
The indicator attached below will automatically plot Mid and Big Figure levels. For example 1.3000, 1.3500, 1.3550 ect. Fun experiment - Load this indicator on a 1H or 15M chart and note how price reacts at these levels.
1. Positive correlation is when two or more pairs trade in the same direction at the same time. For example when EUR/USD is trading up GBP/USD is also trading up.
2. Negative correlation is when two or more pairs trade in opposite directions at the same time. For example when EUR/USD is trading up the US Dollar Index is trading down.
How Can Currency Correlation Help Us Trade Profitably?
Since we know a pair is positively/negatively correlated with another we can look for hints the market leaves behind before a move happens. Woah no way???
What are these hints?
If a pair is positively correlated with another both should be making higher highs or lower lows at the same time. For example view the 4H chart below comparing EUR/USD and GBP/USD
http://i1083.photobucket.com/albums/...ps249fd2f8.png
Each higher high or lower low is happening at the same time stamp!
Knowing this one must ask him/her self what happens when one currency pair fails to follow the above pattern. For example lets say GBP/USD makes a higher high while EUR/USD makes a lower high. This is defined as a crack in correlation or falling out of correlation. Whichever you prefer. Please view the chart below demonstrating how this looks.
http://i1083.photobucket.com/albums/...ps4195dbd1.png
This is exactly the type of situation we are looking for. When two positively correlated pairs fall out of correlation at a major support or resistance level we can expect a reversal. This reversal may be as small as 25 pips but more often than not it results in larger moves. For example today's price action below.
http://i1083.photobucket.com/albums/...pse6c87c22.png
Don't expect 250 pips every time! As stated above the resulting moves can be as small as 25 pips but more often then not 50-100 can be expected. Again I must reiterate this method is to be used in conjunction with major support and resistance levels such as Big Figures and Mid Fgirues for example 1.3500, 1.3550, or in this case 1.3000. Of course it doesn't have to happen at a mid/big figure the only requirement is that it does happen at a major support level such as a daily or 4H.
Negative Correlation
Negative correlation is when two related price units trade in opposite directions at the same time. When EUR/USD makes higher highs the US Dollar Index forms lower lows. Example below
http://i1083.photobucket.com/albums/...ps2c5966c9.png
We can look for a crack in correlation such as E/U making higher highs while USDX fails to from lower lows. Example below
http://i1083.photobucket.com/albums/...ps994388c5.png
Examples with the help of NetDania Charts since Oanda mt4 doesn't offer USD Index.
If you'd like to try NetDania charts follow the steps below.
1. Open NetDania Charts
2. Right click chart > New > Choose instrument
3. Right click chart > Overlay > Second instrument
How the heck do we trade this???
Note: Long term signals are more reliable than short term. 1m is useless. 5m will has more losses than 15m. This isn't to say not to trade the 5m chart though it can be profitable if you trail stops to break even +10 quickly. Most 5m signals are good for 10-20 pips and sometimes it's possible to catch the daily high/low reversal for 60 to 100+. 4H and Daily will provide the most pips but these trades can take weeks/months to reach profit targets. Best case scenario would be to find a 1D+ divergence and 1h divergence forming at the same time @ a major s/r level like 1.3000. This doesn't happen vary often but when it does price explodes.
Click here for step by step trade example
Here are a few options.
Important - Always wait till the diverging bar has closed. For example if a 15M divergence appears on the current candle do not trade till the current candle has closed.
1. Wait for a bar to close in the direction of the divergence signal. Example. E/U makes a higher high G/U doesn't the next few bars happen to be doji's or small greens and finally a bar closes to the sell side. Enter at the close of this bar as long as the divergence is still valid.
2. Trade your favorite system. Look for a signal in the opposite direction of the current trend. <- Scalping systems might get a signal for 15M divergence entry?
3. Wait for a retest of the divergence candle high/low.
4. Set a limit order and wait for the breakout to occur <- Maybe the best option for newbies?
5. Combine 1, 3, and 4 - If when price reverses the risk is vary small enter. If the risk is a little to much for your liking at the next up/down bar wait for a retest of the diverging swing high/low. If price fails to retest set a limit order to breakout trade.
Stoploss
Stops should be set to the most recent swing high/low or x number of pips above/below the swing. In the example below a stop loss would be placed at or above the divergence swing or the most recent swing high depending on when you got into the trade.
Take Protfit
Profit points can be figured a number of ways. I like Fibonacci extensions (swing projection) 1.272, 1.618, 2.0 and 2.618. In extreme cases 4.236 extension will be my last target where all remaining profit is taken. Also note how price acted within these Fibonacci extensions yesterday price ranged between 1.272 and 1.618, stalled around 200% and traded within 6 pips of 2.618 before the market closed for the weekend.
http://i1083.photobucket.com/albums/...psbf0664f3.png
Please note - I (and many others) were taught how to trade this method by mentor Michael Huddleston. My only goal here is to teach you a vary simple and profitable method of trading. If for whatever reason you decide this can't possibly be true please go elsewhere and trade another method.
The indicator attached below will automatically plot Mid and Big Figure levels. For example 1.3000, 1.3500, 1.3550 ect. Fun experiment - Load this indicator on a 1H or 15M chart and note how price reacts at these levels.
Attached File(s)
Mid and Big Figure.ex4
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