Risk & Money ManagementCorrelation Coefficient
Correlation
A statistical measure between -1 and +1 describing how closely the returns of two instruments move together.
What Correlation means
Correlation is normally reported as the Pearson coefficient calculated on periodic returns rather than on raw prices. A value of +1 means two instruments moved in lockstep over the sample, -1 means they moved in exactly opposite directions, and 0 means no linear relationship was present. Trading platforms and analysis sites publish rolling correlation tables computed over windows such as 20, 50 or 100 periods, and the chosen window and timeframe materially change the number reported.
For risk purposes correlation is the tool that converts a list of separate positions into an honest picture of aggregate exposure, since highly correlated trades in the same direction concentrate risk rather than spreading it. The caveats are substantial: correlations drift and can invert with the macro regime, they measure only linear co-movement, they say nothing about causation, and short lookbacks produce unstable readings. Any correlation figure should be treated as a description of the recent past, not a property of the pairs involved.
Worked example
EUR/USD and USD/CHF have historically shown a strong negative correlation near -0.9, so a long EUR/USD position combined with a short USD/CHF position roughly doubles a single directional bet rather than diversifying it.
Related terms
- DiversificationSpreading capital across instruments or strategies whose returns are imperfectly correlated in order to lower portfolio risk.
- ExposureThe total market risk an account carries, measured by the aggregate notional value of its open positions.
- HedgingHolding an offsetting position in order to reduce or neutralise the risk of an existing exposure.
- VolatilityThe magnitude of price fluctuation over a period, usually measured as the standard deviation of returns or as an average range.
- Currency PairTwo currencies quoted against each other, expressing how much of the second currency one unit of the first is worth.
Frequently asked questions
What does Correlation mean in forex trading?
A statistical measure between -1 and +1 describing how closely the returns of two instruments move together.
How does Correlation work in practice?
For risk purposes correlation is the tool that converts a list of separate positions into an honest picture of aggregate exposure, since highly correlated trades in the same direction concentrate risk rather than spreading it. The caveats are substantial: correlations drift and can invert with the macro regime, they measure only linear co-movement, they say nothing about causation, and short lookbacks produce unstable readings. Any correlation figure should be treated as a description of the recent past, not a property of the pairs involved.
What is an example of Correlation?
EUR/USD and USD/CHF have historically shown a strong negative correlation near -0.9, so a long EUR/USD position combined with a short USD/CHF position roughly doubles a single directional bet rather than diversifying it.
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