TRADING CORRELATION PT 1- EURUSD: SELL EUR$ ON DXY MOVES HIGHER This 2-part article will look at the practical application of correlations in trading and show how to use correlation inferences to exploit the statistical advantages they offer.
On the 4h time frame, the highest day-tradable timeframe imo we see EUR$ has an exclusively negative and almost 1for1 correlation with the dollar index (or dollar "market"), however, despite popular belief EU actually has a mixed and weak correlation with GU (as we see the EU v GU correlation move from positive to negative several times).
This relationship is backed up by EU price action currently trading at +2sd of the mean, whilst GU performs the stark opposite at -2sd of the mean.
We can use this information in 2 ways to trade the 4h time frame - please bear in mind this is the 4h timeframe only, corrs differ using different time-frames.
1. We know that EU and GU dont hold any confident correlation thus we SHOULDNT make trades based for EU based on GU - despite many people often trading EU based on GU moves.
2. Instead, we know 4h EU is highly correlated with the $ Market, thus we CAN make trades based on $ Index moves - so personally, i will wait for the $index to move/break higher, at which point i will then SHORT EU, since they have a 90%+ negative correlation relationship which is rising atm.
- This imo gives us a perfect entry signal, once $ Index moves up we can then short the overweight EU which is trading at highly volatile levels above its average.
I also like short EU fundamentally for:
FOMC hawkish or hike on the 16th - must push eur$ lower
BREXIT 23rd june - UK Referendum imo has NOT yet been priced at all in downside euro's yet (especially compared to GU, this is the main driver for the increase in negative corrs between the two pairs currently)
ECB poor econ management - Eurozone is STILL suffering with below 0% inflation and 10%+ unemployment, i think this trend will continue throughout the year and ECB will have to do more printing/ issue more EURO supply side, thus moving EU down - especially if the FOMC hikes and the Monetary policy diverges more.
I will shortly release a follow up article, looking at a higher time-frame to illustrate the different tradable inferences we can make.
