Correlation Indicator

Correlation Indicator

Ideal indicator for predicting future price movement. A suitable tool for visually observing how two currency pairs correlate.

Forex Currency pairs are correlated. The correlation could be positive, negative, or zero correlation. A positive correlation means two currency pairs will follow a similar trend. In other words, the currency pairs would both follow an uptrend when the bulls are in control of the market. Similarly, a downtrend in one currency pair should be exhibited in the other. Essentially, the trend in one is currency mirror reflection in the other pair.

Now, why is correlation important in forex trading? Understanding correlation helps to plan your lot sizing. For instance, trading two currency pairs with negative correlations amount to naught work. The profits from the two trades will cancel each other. On the other hand, opening two trades with a positive correlation is equal to double trading. Therefore, you risk overtrading and risking a substantial portion of your account.

Correlation Indicator
The correlation indicator shows the price movement of two correlated currency pairs. Essentially, observing two correlated pairs gives you additional information about their market behavior. This means you can pick turning points of the market more accurately. The indicator is a perfect tool for identifying trading opportunities in the market.

How to Use the Correlation Indicator
The correlation indicator does not produce buy and sell signals all by itself. Instead, it overlays a second currency pair on the existing price chart. That means you will view the price movement of the currency pair displayed by the chart and the one mounted by the indicator. Therefore you can watch how the market unfolds candle by candle in the two currency pairs.

Now how do you use the indicator to open buy and sell indicators? Essentially, if the two currencies have positive correlation they should exhibit the same trend. Therefore, if two positively correlated currencies show a trend disparity, that is a trading opportunity. For instance, you can capitalize on buying or selling one of them because the price will eventually follow the same direction again.

Trading Example

The price chart shows the price moment for Great Britain against the US Dollar. The indicator line mounts the price movement for the EURO against the US Dollar. The EURUSD and the GBPUSD have a positive correlation. According to the price chart, the EURUSD exhibited a sharp price decline as shown by the red arrow.

While the GBP is also in a downtrend, the movement is not that sharp. However, since they have a positive correlation, we expect the market trend of GBPUSD to be the same as EURUSD. True to the indicator, the price eventually also falls sharply.

Conclusion
The correlation indicator for MT4 is suitable for forecasting the future movement of positive or negatively correlated currency pairs. Positively correlated pairs eventually follow the same price direction, while negatively correlated currency pairs follow an opposite direction. A trading opportunity appears when the currency pairs fail to follow this rule. Since the indicator does not give straightforward buy and sell signals, it is prudent that you use it in combination with other tools.