A correlation can be positive – when the prices of two currency pairs move in the same direction – or negative, when the prices of two currency pairs move in opposite directions. Forex traders need to understand the relationship between currency pairs because they can affect a trading account’s exposure and risk. Currency pairs consist of two different currencies that are evaluated with respect to each other. Each currency belongs forex currency pairs correlations an economy, so this can affect the supply and demand for the currency.
This means that currencies cannot be traded separately. However, this does not mean that the value of a currency will change at the same rate against all other currency pairs. For example, if the euro appreciates against the US dollar by 50 pips, it will not necessarily increase by 50 pips against the Australian dollar, but there is a strong likelihood that the EUR will appreciate against the Australian dollar to a certain degree. A positive correlation means that two currency pairs move in the same direction. USD consists of the euro and the US dollar. USD decreases, it either means that demand for the euro is decreasing or that demand for the dollar is increasing. Both scenarios lead to a depreciation of the EUR in relation to the USD.
A negative correlation means that two currency pairs move in opposite directions. Traders need to take into account the correlations of different currency pairs if they wish to trade multiple parities. Currency correlations can increase the overall risk of a trading account. USD position, one position will produce a profit and the other one a loss. Initiating opposite positions on currency pairs with a strong positive correlation is counter-productive.