Module 1A: Forex Foundations · Lesson 3 of 4 · Back to course
Open charts of EUR/USD and GBP/USD side by side and you’ll often see them rise and fall at the same time. That’s not a coincidence. Both pairs share the US dollar, and the euro and the pound are often affected by similar news. This tendency for markets to move together (or in opposite directions) is called correlation.
Correlation matters to beginners for one big reason: if you don’t understand it, you can take what looks like three small trades and end up with one large bet.
What correlation means
Correlation is measured on a scale from −1 to +1:
| Value | What it means | Plain English |
|---|---|---|
| +1 | Perfect positive correlation | The two always move in the same direction |
| +0.7 to +0.9 | Strong positive | They usually move together |
| Around 0 | Little or no relationship | Knowing one tells you little about the other |
| −0.7 to −0.9 | Strong negative | They usually move in opposite directions |
| −1 | Perfect negative correlation | They always move in opposite directions |
Real markets are never exactly +1 or −1, and the number changes depending on the period and timeframe you measure.
Why currency pairs are linked
1. They share a currency. EUR/USD, GBP/USD, AUD/USD and NZD/USD all have the US dollar as the quote currency. When the dollar strengthens broadly – after strong US jobs data, for example – all four tend to fall together.
2. The dollar sits on different sides. In EUR/USD the dollar is the quote currency; in USD/CHF it’s the base. So a stronger dollar pushes EUR/USD down and USD/CHF up. That’s why those two pairs have often shown a strong negative correlation.
3. Economies are linked. The UK and the eurozone trade heavily with each other and are often affected by the same events. Australia and New Zealand are similar. Linked economies tend to have linked currencies.
4. Market mood. On risk-off days, “safe haven” currencies such as the yen and Swiss franc often strengthen together, while growth-linked currencies such as the Australian dollar often weaken together. See Risk-on vs risk-off.
Relationships traders often watch
These are tendencies observed over many periods, not fixed rules:
- EUR/USD and GBP/USD: often positively correlated (shared quote currency, linked economies).
- EUR/USD and USD/CHF: often negatively correlated (the dollar on opposite sides).
- AUD/USD and NZD/USD: often strongly positively correlated (linked economies).
- GBP/USD and EUR/GBP: often negatively correlated, because the pound sits on opposite sides.
Any of these can weaken or flip for weeks or months – for example around a UK-specific event such as a budget, an election or a surprise Bank of England decision, when the pound moves on its own.
How to measure it yourself (free)
You don’t need special software:
- Export or copy 60 daily closing prices for two pairs into a spreadsheet (columns A and B).
- Work out the daily percentage change for each: in C3 type
=(A3-A2)/A2, and in D3=(B3-B2)/B2. Copy them down. - In any empty cell type
=CORREL(C3:C61,D3:D61).
Using percentage changes rather than raw prices gives a more honest number – two prices that both drift upwards can look highly correlated even when their day-to-day moves aren’t.
Repeat it every month or so. Watching how the number changes over time teaches you more than any single reading.
Why it matters: hidden doubling-up
This is the practical part. Suppose your plan is to risk 1% per trade.
All figures are made up for teaching purposes. They aren’t real prices or a trade idea.
Account: £5,000. Risk per trade: 1% = £50.
On Thursday morning you see three “different” buy setups and take all three:
- Buy EUR/USD – risk £50
- Buy GBP/USD – risk £50
- Sell USD/CHF – risk £50
Each trade looks like 1%. But all three are really the same bet: the US dollar weakens. If strong US data comes out at 13:30 UK time and the dollar jumps, all three can hit their stops within minutes. Your loss: £150, or 3% – three times what your plan allows.
A simple fix many traders use: treat strongly correlated trades as one position. If you want exposure to a weaker dollar, either take one trade at 1%, or split the 1% across the three (about £17 each). Correlation and over-exposure shows how to count this properly.
Correlation can also cancel out trades
The opposite mistake is less dangerous but still costly. Buying EUR/USD and buying USD/CHF at the same time is close to betting both ways on the dollar. You pay two spreads, and the trades may largely cancel each other out.
Common mistakes
- Thinking more trades means more diversification. Five dollar trades are one dollar bet.
- Treating a correlation figure as permanent. It’s a measurement of the past, not a promise.
- Measuring on prices instead of returns. It can make unrelated markets look linked.
- Forgetting other markets. Gold, US indices and some currencies can all react to the same dollar move.
The prop firm angle
Correlation is one of the quietest ways to break a daily loss limit. Three trades at 1% each that are really one bet can turn a normal losing trade into a 3% day – and with a 4% or 5% daily limit, you’ve used most of it in one news release. Before opening a new position in a challenge, ask: “Is this the same bet as something I already hold?” Many traders also set a cap on total open risk, such as 2%, counting correlated trades together.
Key takeaways
- Correlation runs from −1 to +1 and describes how closely two markets move together.
- Pairs sharing a currency, or with linked economies, often move together.
- Correlations change, so measure them regularly on percentage changes.
- Treat strongly correlated trades as one position when you add up your risk.
Quick quiz
- What does a correlation of −0.8 suggest? (The two markets have usually moved in opposite directions.)
- Why do EUR/USD and GBP/USD often move together? (They share the US dollar as the quote currency, and the UK and eurozone economies are closely linked.)
- You buy EUR/USD and sell USD/CHF. What single bet are you mostly making? (That the US dollar will weaken.)
- Why measure correlation on daily percentage changes rather than prices? (Prices that both trend can look correlated even when daily moves aren’t.)
- Three correlated trades each risk £40. Roughly how much could you lose on one news release? (About £120.)
Key terms
Correlation · Exposure · Quote currency · Base currency · Risk-off · Safe haven · Daily loss limit
Try this
Pick four pairs: EUR/USD, GBP/USD, USD/CHF and EUR/GBP. Using the spreadsheet method above, work out the 60-day correlation for each combination (six pairs of pairs). Write the results in a small table. Then go back through your demo journal: were any of your trades on the same day really the same bet?
FAQ
Is correlation trading a strategy? Some professionals trade the relationships between markets, but it’s complex and the relationships can break. For beginners, correlation is mainly a risk-control tool.
Can I hedge one pair with another? In theory, a negatively correlated pair can offset some risk, but you pay two spreads and the relationship isn’t reliable. It’s rarely a good idea for beginners.
Which timeframe should I measure? Daily data over 60 to 120 days is a sensible starting point. Shorter periods jump around a lot.
Disclaimer: This page is general education, not financial or investment advice or a personal recommendation, and it doesn’t take your circumstances into account. Examples are hypothetical, for illustration only, and not an invitation to buy or sell. Learning a strategy doesn’t guarantee profits. Past performance is not a reliable guide to future results. Futures, spread bets and CFDs are complex and carry a high risk of losing money quickly because of leverage, and most retail traders lose money. With a real futures account, losses can exceed your deposit. Only trade with money you can afford to lose, and speak to an independent FCA-authorised adviser if you’re unsure. Read our full risk warning.