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Chapter 37, Part II. Application of Intramarket Correlations. Page 2

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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    4. Risk hedging. This is the topic of our advanced discussion. Although the surface thought is that you may lock your position by another pair with high correlation – it’s not so simple. The point is that two pairs could have and much of the time do have different pip value. Also in the short-term, correlation is a subject to change and not so stable, so pip value also will fluctuate. But in general, let’s suppose that you intend to enter long EUR/USD, but are not sure from which level. You have two possibilities – enter long with part of position and add more later, or enter with normal size but combine it with a long USD/CHF position lesser size. This will give you some advantages. First – the pip value will be different, so you may do fine tuning of your position value, based on overall risk that you intend to take at the first entry point. Second, when and if the market will reach your second entry point – you can close USD/CHF position and get some profit on it. But this is a simplified understanding of hedging. Real procedure we will explain later in this lesson.

    5. Correlation gives you a confirmation tool of different breakouts and trends. Since you know what pairs are highly correlated between each other – you may use their price action to judge about the truth of some breakouts or trends. For example, if the EUR/USD starts to rise significantly, but Cable and USD/CHF stay flat and do not support this run – then, probably this move is mostly due to EU news or events and has no relation to the USD. This could lead to possible reversal on the EUR/USD after the market will adapt to the news. So, if there is no agreement in highly correlated pairs’ movement – this should be a sign that this run on a particularly pair could stop soon. If you still want to trade it – reduce your lot size.

    6. Finally, correlation is subject to change when you do not wait it. Indeed, correlation is different each time that you calculate it. It could be high during the recent week while it could be less during the previous 3 moths. So, you have to update correlation data regularly, if you will use it.
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