How Does the Strategy Work?

The correlation trades often act as a pseudo-hedge because the currency pairs that make up a correlation trade have one specific currency that is common in all of the currency pairs being traded. The currency pairs are traded in a manner where the common currency is often hedged. The trader must understand what currency pairs sufficiently correlate and if the correlation is positive or negative so that the direction each pair must be traded can be determined. There are only a limited number of combinations that can be traded to satisfy the criteria of correlation trading and often these combinations are constantly changing due to market conditions.

Perspective of a Correlation Trader

Correlation traders recognize and realize the degree of randomness in the foreign exchange market and embrace the random price movement by employing strategies that allow a trader to potentially benefit from the randomness.

For Example:

·         A trader who buys the EURUSD will only have one opportunity to be profitable and that opportunity will only present itself if the pair goes up.

·         From the perspective of a correlation trader, a correlation trade has the potential to profit regardless of the direction the market moves.

·         For example, if the EURUSD and the USDCHF are bought simultaneously and both trades are viewed collectively as one correlation trade, there will be two primary opportunities to be profitable:

o   There will be profit if the EURUSD rises sufficiently above any draw down that the USDCHF may have; and

o   There will be profit if the USDCHF rises sufficiently above any drawdown that the EURUSD may have.

• The multiple opportunities for profit allow the trader to profit regardless of the direction the market moves if the correlation trade has been well planned.