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LESSON: How to Integrate Correlation into Your Trading Edge

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[op_liveeditor_element data-style=””][text_block style=”style_1.png” align=”left” font_size=”16″ font_font=”Montserrat” font_color=”%237e7e7e”]Trading SMART is not harder than trading DUMB . My three personal rules for correlation are like most of my rules in my plan. They are simple, very effective, easy to understand and proven over time.

Side Note: We do not look at or need to use any sort of correlation graphs, charts or indicators. We are concerned with risk management and ensuring we manage our overall account risk to never put ourselves at over-risk.

The Rules To Ensure Risk Stays In-check

1) I never enter two full size trades with the same currency in them.

For example; I would not open both the AUDUSD and the EURUSD at the same time as they both have the USD in them, and any unfavorable news or data in the USA will affect both my trades. Basically I never want to have twice the risk to any one region, zone or currency.

Another example is EURJPY and GBPJPY as I would be doubling up on risk with the JPY .

2) I can enter 2 x pairs that are strongly correlated (same currency / zone), if I reduce my risk over the two trades to reflect the risk that I would normally have on one trade.

For example; If I see setups that I equally like on the GBPJPY and EURJPY, and I like them both and can’t choose which one I want to enter, instead of risking 3% on both and now potentially losing 6% if they BOTH LOSE!

You could take both trades, but half your normal risk. If you normal risk is 3%, then make it 1.5% on each of the two trades and you are still risking 3% in the markets and trading both setups – or you choose the #1 trade you like best.

This quite often happens where if one EUR or GBP pairs fires off a setup 2 or 3 other pairs will form very similar setups.

You use this same method if you use the fixed money method. If you normally risk $200 per trade, then half that and risk $100 per trade.

3) I am permitted to enter a second trade with a highly correlated / similar currency only when the first trade has moved to break even.

This is so I am not doubling up on my risk or taking on any further risk in similar markets or currencies. When the first trade is at breakeven it is no longer a chance of losing and only then is it okay to take on another full ‘risk’ position as the risk has been minimised of two losing trades.

Lastly on Risk and Correlated Markets Currencies

After you have some trading experience you will begin to notice which pairs move together and your risk tolerance.

The whole idea of using correlation information is to minimise your risk levels. You do not want to be doubling or tripling up your risk into the same countries or areas for example USD / EUR / AUD / JPY etc either through % or $, that is it!

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