[op_liveeditor_element data-style=””]

LESSON: Why Correlation Is Important?

[/op_liveeditor_element]

[op_liveeditor_element data-style=””][text_block style=”style_1.png” align=”left” font_size=”16″ font_font=”Montserrat” font_color=”%237e7e7e”]The two major reasons we consider correlation when we are trading are;

1. Trading more than one pair that is correlated means you are doubling or more up on your risk.
2. You can be hedging against yourself – in other words making a trade off and having trades counter each other out

The risks of over-risking are pretty obvious and whilst hedging against yourself is not as dangerous it is just as unintelligent.

Examples:

Example of doubling up on risk: Trader Carly decides on Monday to trade the EURUSD long, and enters her position. On Tuesday Trader Carly spots another trade, and enters long, on the GBPUSD. Carly is now in two trades that are both closely correlated.

If both of these pairs go up she will make twice the profit. If however; these trades go down she will ultimately lose both of them.

Example of hedging your trades: Trader Dave spots a great looking setup on the 4hr chart of the EURUSD to go long . He also spots a nice setup on the 4hr chart of the EURJPY to go short .

He likes both these trades and enters a full position on the both. Trader Dave has now effectively increased his chance of losing whilst cutting he’s chances of winning! EURJPY and EURUSD are closely correlated and taking trades in the opposite direction is nearly assuring one trade will win and one trade will lose. Effectively losing either way due to paying the pip spread to your broker![/text_block][/op_liveeditor_element]