Currency Correlation – Breakouts
Correlation. Pronunciation:/ˌkɒrəˈleɪʃ(ə)n, -rɪ-/ “a mutual relationship or connection between two or more things” (Oxford English Dictionary).
We have written a few posts on FX correlation and cross currency analysis trading before in the blog and often reference the currency “relative strength” charts when looking for the strongest v weakest to trade. Today the markets gave an excellent opportunity to catch a breakout trade as the GBP/USD pair was slow to react to dollar weakness across the board. Cross market analysis/currency correlations gave an excellent insight into the prevailing market sentiment.
One way of looking at correlation setups is using something like an opening range breakout; the ACD method by Mark Fisher can be used in this way. Anyway, back to the example at hand…
Let’s start by looking at three charts (4 hour timeframe) showing GBP/USD, EUR/USD and USD/CHF respectively.
With the above in mind we can then look for a setup as we never enter blindly and would need to quantify the risk with a stop loss and take profit target, or indeed a trailing stop. When we go to the lower timeframe the early stages of a trend line breakout higher can be seen. Furthermore, the chart shows how price has closed above the trend line and therefore confirmed the entry to a certain degree. So, at this stage we know two things about the market:
- The dollar is under pressure and is loosing ground against multiple currencies (further to the ones I have showed above there was a breakout on USD/CAD and, more to the point, the U.S. dollar index).
- We have a trade setup, in the direction of the near term trend/current market sentiment, on the pair that is lagging – GBP/USD in this instance.
Now there will be days when the currency which is lagging is doing so for a very good reason. It’s sometimes worth checking the news to see if there is any obvious reason. If everything appears to be sound then the currency may be ready to follow the others and breakout…
And here we have it; GBP/USD (see below) has now followed the other pairs and moved significantly to the upside. The market had shown us that the dollar was not in favour today and we identified a setup to utilise in order to trade against this weakness. It’s not always going to be a case of taking a trade – sometimes this currency correlation analysis is going to keep us out of the bad trades when we realise that the opposite has happened and we were just about to trade the one pair that had a breakout, while the others were not ready to follow.
The above is just another example of how we prefer to see many elements working in our favour when looking for a setup. A currency correlation strategy is just one approach that can be used to filter the numerous setups we see when analysing the Forex market. New traders often look at seemingly good technical setups that have “failed” and dismiss technical analysis on the strength of this… Sometimes they need to look at the big picture…
As ever, this is not a recommendation to go out and trade these setups blindly; the intention is to give people something to think about and test themselves through a demo trading account without risking any money. Never risk any money on the back of what we say or anyone else – do your own due diligence at all times.
Hopefully you have enjoyed this overview, giving another look at how we view the Forex market. Remember that money management, trading psychology and all round continuous self improvement are vital if you aspire to trade the markets successfully.
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