Correlation

I read that GBPJPY is positively correlated with CHFJPY. ie, if GBPJPY go up, CHFJPY also go up.

I fully understand what correlation is. But what I dont understand is the correlation number.

ie, GBPJPY and CHFJPY has a +80 correlation.

I know that a correlation of 100 will exactly mirror each other. But what about 80? does 80 mean 80% (ie, GBPJPY go up 100pips, CHFJPY go up 80pips) ?

Or is there some other Magic involved?

No.

It means that they move The Same Direction 80% of the time.

And just to add to the already burgeoning info on correlation...

check this out
http://www.mgforex.com/eng/forex-too...-rates.htm?d=y

If you do a search on the Forum for either correlation or user name isotonic you'll find his thread.
He's the guy to ask about this stuff
Peter

I see.. So this correlation number is more like a chance that they move along the same direction BUT NOT in the same quantity.

It now makes sense to me that GBPJPY moved 2000 pips since Jan 2006 while CHFJPY moved only 500 pips... I cant rely hedging Long GBPJPY with a Short CHFJPY... It is only coincidental that GBPJPY kept moving up and up in favor of this carry trade thing! Nonetheless, it is not ideal to hedge these two pairs as the pip movement is totally not the same.

Sure wished i started doing this much sooner (like since July perhaps)..

The correlation of two functions f(t) and g(t) is just the integral of their product (f(t)g(t)) divided by their respective rms fluctuation. Instead of integral lets just use the word sum.

Take the time data for two currency pairs, call it f (i.e. EUR-USD) and g (i.e. GBP-USD)...use their closing value at each point. Now at each point in time calculate f*g, f*f and g*g. Now Sum all the points (S(f*g) = sum of f*g over all the points). Now take the value S(f*g)/[(S(f*f))(S(g*g))]^{1/2}, where []^{1/2} means take a square root. The above value is the correlation number. So it depends on them both moving in the same direction since the magnitude by which they move is divided out.

Really strong correlation happens when a cross doesn't move that much. For example, take the three pairs EUR-USD, USD-GBP, GBP-EUR. By definition:

(EUR-USD)*(USD-GBP)*(GBP-EUR)=1

otherwise I could trade in circles and make a profit.

Now, (GBP-EUR) doesn't move that much. In fact its pretty darn dead relative to EUR-USD and USD-GBP. So lets, for the sake of argument, say it doesn't move at all and has a constant value of 1.5 or so.

Then that means (EUR-USD)*(USD-GBP)*1.5=1
or (EUR-USD)=1/(1.5*(USD-GBP))
or (EUR-USD)=0.6(GBP-USD) (because 1/(USD-GBP)=(GBP-USD))

And here you see the correlation and the magnitude. So if you were hedging EUR-USD to GBP-USD take into account for every lot you take in EUR-USD you need only hedge 0.6 of that in GBP-USD. i.e. buy 10 lots of EUR, sell 6 lots of GBP should be a good hedge.

Of course...that assumes EUR-GBP doesn't move much during the hedge....and thats the gamble.

I see, so if I were to hedge GBPJPY with CHFJPY, should do:

2 lot GBPJPY
3 lot chfjpy ???

darn... open a non-interest bearing account would be better and save me the headache.... x(

thus far only marketiva.com offers absolutely NO interest/commission for holding a possition..... other brokers are cheats: fxcm/gft will charge correspionding commissions to the effect that i will pay it daily and higher than swaps!

(GBP-JPY)*(JPY-CHF)*(CHF-GBP)=1
So, say CHF-GBP assumes its current value around 0.43:
(GBP-JPY)*(JPY-CHF)*0.43=1
or
(GBP-JPY)=2.3*(CHF-JPY)

So if CHF-JPY moves 1 pip GBP-JPY moves 2.3. That means to balance (assuming JPY base currency) I need 2.3 lots of CHF-JPY to balance each lot of GBP-JPY. So, to get hard numbers 7 lots of CHF-JPY for 3 lots of GBP-JPY should do it.

I should point out...this hedge wouldn't be great. CHF-GBP is nowhere near constant. So this hedge would move with CHF-GBP. Thats what makes the EUR-GBP-USD mix so nice, EUR-GBP is pretty immobile.

Hi All,

The correlaton between two pairs is not always be the same..

if you see correlation table today and the next day / week in http://www.mataf.net let say for GBPJPY with CHFJPY.. the correlation value
could be different.

how to get the value of correlation is very simple...
first you must determine :
- HOW MANY CANDLE TO COUNT and
- what TIME FRAME
from this clue.. you too understand why two pairs with different time frame produce different correlation value.

here are the example.. :
let say you want to know the correlation between GBPJPY and CHFJPY
in 5 candles (last 5 candles)

check for each pair wheter bullish or bearish from candle 5 to candle 1 (now)

5 4 3 2 1
GBPJPY bullish, bullish, bearish, bullish, bearish
CHFJPY bearish,bullish, bearish, bullish, bearish

we can see above that all candle showing same direction but candle 5.
it means that GBPJPY and CHFJPY have same direction 4 candle from 5 candle.. 4/5 = 80 %

the formulation is as simple as that.. but dont forget about volatility... if you want to do hedging with other pair, because it determines how many lot size you use in other pair

Best Regards,
- Mike -

You could just go here: http://currensys.com/correlation.php It has 30 currencies and 4 different time frames. More than any other website.

It has a flaw. When you try to scroll up or down from looking at one of the cross correlations in the middle the number given is the last one the pointer was over. This is even true when I click, say on aud/jpy, aud/chf... it doesn't hold the number.

Did FF make you take the link out of your profile page?

Hi StockJay, thanks for the feedback. I see what you are saying about scrolling. I'll point that out to the programmer but I'm not sure that can be fixed. As soon as you move your mouse, the number does update to the correct value. The table was not designed to hold a number when you click a cell. It's just a place keeper.

I'm not sure what happened to the link. It's in my profile but doesn't show up. I assume that happens to everyone.

That has absolutely nothing to do with correlation.

Hey all

I run a little Thread at T2W and discuss Correlation and strengthmeters

Strengthmeters appear to be flavour of the month with Marketeers right now and they are charging silly money for Free strengthmeters ....although some of us are now fighting back http://cdn.forexfactory.com/images/s...m/thumbsup.gif

http://www.trade2win.com/boards/fore...ml#post1109482

happy to help and progress this thread

Neil
NVP

Hello，

excuse me ,i want to know how to calculate 80 percentage？ by some instrument or tool？