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Chapter 37, Part I. Intramarket Correlations. Page 5

Discussion in 'Complete Trading Education- Forex Military School' started by Sive Morten, Dec 28, 2013.

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  1. Sive Morten

    Sive Morten Special Consultant to the FPA

    Aug 28, 2009
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    Commander in Pips: Well, with our simplified understanding this will give you just 0.07 lot in EUR/USD, or we can round it to zero – but this position has no sense. But, you should not invent the bicycle here – just enter long with EUR/GBP, if you want. Second, since correlation of these pairs is significant, their volatility might be different – and you probably will end your trade with some small loss or profit. Still this trade looks doubtful. You will not be able to predict corresponding moves of these pairs. One way how correlation has to be used here – is for understanding that your risk will double and adjust your trading lot accordingly if you still want to enter the same direction with EUR as with GBP – to match your risk management system.

    Probably you’re right, I understand. Enter with 2 lots of EUR/USD – will be almost the same… or with 2 lots of GBP/USD.

    Commander in Pips: Absolutely.

    Wait a minute, let me guess. If we will take highly negatively correlated pairs – for example EUR/USD and USD/CHF and take opposite positions with them – look chart below… This will be the same as taking one direction positions on positively highly correlated pairs, right? So enter long with EUR/USD and simultaneously short USD/CHF will give us the same as enter long EUR/USD and GBP/USD or enter with twice the size long on EUR/USD?

    Chart #2 | EUR/USD and USD/CHF Weekly

    Commander in Pips: You understand everything correctly. If we speak about it in terms of risk and correlation – that’s it. The major thought that we are discussing now is that we have to understand and recognize in time when we increase our risk exposure. This could seem that we reduce risk when open position with 2 different pairs – in reality we should look at this through correlation. From the other point of view – open opposite positions in highly positively correlated pairs or same position in highly negatively correlated pairs have no special sense – because you will just cancel your initial position by this action. You may finish with some loss or even profit, but it will be small and hardly could be predicted. You may even finish with a loss on both positions.

    P.S. This lesson was written by Sive Morten, who has been working for a large European Bank since April of 2000, and is currently a supervisor of the bank's risk assessment department. Sive's knowledge of forex market and banking industry is vast and quite complete. If you have any specific questions about forex, banking industry, or any other financial instruments, please post them below, we'll notify Sive, and get them answered within 1 week.

    Note: FPA ranks are earned in the battles against scam, not in the classroom.
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