Correlations and Entry Signals

Hello.


I wanted to know the approach that traders on this forum take. Lets say that EUR/USD is in a strong bearish movement and you get a sell signal on another instrument that has inverse correlation, meaning that when EUR/USD goes down this other instrument should go up. Do you still take the signal? How do you deal with the correlation/ inverse-correlation of instruments?

I always thought that traders should only trade one instrument at a time. Because when your in a trade and have a position in multiple instruments its a mess since one instrument can be going up while the other is going down (Inverse). Both could be going up or down (Correlation) - but you are just adding on to risk.

​How do you deal with this, or how should I go about it?

I trade only one pair eur/usd, I do not look on other pair. its enough for me to get money from one pair. and my trading style I called its a thief style. so I do not have experience on managing multiple pair or commodity.

I trade 31 pairs, also several futures. I look long term and those setups only come every once in awhile. I have done the day trade thing and have spent thousands on programs, systems, morning calls, ect none with a glimmer of profit but back then I didn't have what it took to be a trader anyways. Dealing with correlation and inverse correlation is what separates the men from the boys. Only screen time and experience will help you with that. For instance, if I am looking at a pair and the trend seems very bullish I might jump the buy signals early because it might not get down to the actual buy level. On the other side of I am looking to sell, but the trend is positive and seems like it is running out of steam, I might let some price action go against my sell signal before I enter. Everybody has their own way.

Hello Eldavidoloco

The idea of correlation is a valid one and one that can be utilized but with a few caveats. Try to keep in mind that each pair is a unique market. And the country that takes the other side of the common currency (in this case USD) has its own set of fundamental and technical drivers. So while the correlation does exist, the "correlated market" will most likely NOT behave in the same way as the market you are using to correlate.

Therefore I have advocated that each market be traded as an independent instrument based on (whatever) metrics or method you use to enter and/or exit.

Keep in mind that correlation is NOT causation. As an example: It can be argued that 85% of the people who die in Germany have eaten pickles in their life...does that mean pickles are the dangerous to one's health? There is a correlation, but that is not causation. Just because one market moves doesn't necessarily mean that the other will move or that it will move in the same way.

Thus if you have a sell signal on one pair that you consider valid and you have a plan that specifies risk determination and clear objectives...take the signal...you may be surprised that they BOTH work, even though they are moving in opposite directions.

With the system I trade, correlated signals are traded simultaneously. When the correlated trades lose, the maximum loss is 4%. When the correlation is favorable, it will go as high as 30%.

I thank all of you that have replied, I appreciate your time. I see that for the most part correlation is not such a problem when it comes to long term trading. By long term I mean trading styles from swing trading and above. I say this because a stop for these styles of trading is already at a level where intra-day correlation should not affect it, allowing the instrument to make its true move over time.

I believe that correlation plays a major role when trading intraday.

related pairs and correlation are the key ingredient to my method.as gaspion has mentioned it is not something written in stone,but if you spend enough time studying the movements and the causes and effect i,i would say there is more than enough information to trade consistently profitable.its not so much looking for highly correlated pairs ,its understanding which way the flows of money are entering or exiting the market.

there are many advantages ,you can see and often determine advanced warning of break out at stall point.momentum and increased volume and the list goes on and on

My suggestion is not to use the correlations as a direct trading signals but to look at the alternative advantages ,

If you group ,basket the predominant currencies ,ie dollar ,yen and risk ,whilst considering the how positive or negative the correlations are you will begin to see more than a chart can offer .combined with average price and extreme levels ,stalling points within the whole market you will be plesently surprised what you can find