The importance of correlation in hedging

Definition:

Knowing the definition of correlation can be very helpful in FX trading.

Correlation is a mutual relationship or connection between two or more pairs.

The value of a correlation coefficient ranges between -1 and 1.

The greater the absolute value of the correlation coefficient, the stronger the linear relationship will be.

The strongest linear relationship is indicated by a correlation coefficient of -1 or 1.

A positive correlation means that if one pair's price rises the other pair tends to rise and vice versa.

A negative correlation means that if the price of one pair rises, the other pair's price will fall.

Use of correlation in hedging:

Hedge traders use pairs with correlations to hedge fund against each other. This means that they open two positions which have a good absolute correlation at the same time.

This will reduce the risk but also reduce your chances of gaining more profit.

You can't find pairs with 100% absolute correlation. But there are many pairs with correlation very close to 100% (-1 or 1). If the correlation is high (normally above 80) and positive then the currencies move in the same way. If the correlation is high (normally above 80) and negative then the currencies move in the opposite way.

• Use of pairs with positive correlation:

If you want to use pairs with positive correlation for hedging, you should by a pair and sell the other pair.

• Pairs with negative correlation:

To get the advantage of hedging using pairs with negative correlation, simply buy or sell both pairs. This means if one pair goes up the other will goes down. 

Some of the pairs with negative correlations:
This may change, so always check the recent data and graphs.

#EURAUD - #AUDJPY
#EURAUD - #AUDUSD
#EURAUD - #AUDCAD
#EURAUD - #SGDJPY
#EURAUD - #NZDJPY
#EURAUD - #USDSGD

#EURUSD - #USDCHF

Some of the pairs with positive correlations:

#EURUSD - #GBPUSD

#AUDUSD - #EURUSD

#GOLD and #OIL

Gold and Oil's correlation is different from the FX pairs.
Gold and Oil normally have a good positive correlation on longer timeframes like weekly time frames. The reason is that investors are looking at Gold as a safe haven in financial crises.

There is a reliable scenario: If the price of Oil goes high, the inflation goes high. During the high inflation, investors tend to invest more in Gold. This will cause the gold price to rise.

In shorter time frames we can not see any correlation between these 2 though. You may notice during a period of time they have negative correlation and on some other days no correlation at all.

Risk management

If a trader doesn't know the correlation he or she may increase the risk. Imagine someone opens 2 buy positions with 2 pairs which have a positive correlation. This means if one pair hits the stop loss the other pair also may hit the SL.

The stop-losses are an important tool in Forex trading to limit losses. You simply can’t be successful in the long run if you don’t limit your downside by using stop losses.

The hedging strategies work the same way like a stop loss order in terms of limiting losses. However, the advantage of hedging is that you can also make money on the hedge trade depending on the second trade selection. However, you need to take into account the carry on costs of leaving a trade open for a long time.

To be successful in hedge trading

The correlation between different markets always changes. So we should review the charts constantly to see if the correlation changes or not.
Looking at the following picture, we will notice how nicely #Gold and #BTC have been correlating during the past few months.
To lern more about hedge trading please also read the following posts from this weblog:

The importance of correlation in hedging

Hedge Trading

Diversification in Online Trading

 The importance of portfolio diversification. 

To have a diversified portfolio you should follow these rules:

1. Spread your risk to increase your portfolio’s success.

• Invest in assets that will react differently to the same market factors. 
• For example, do not hold different travel industry related securities, as these assets have a high correlation. You can read about correlation here. This is not diversification. Holding highly correlated assets increases your risk.
• Instead invest in different assets which are not correlated to each other geographically, industry base, type. For example have some tech ( Google, etc), travel (Airlines, Cruise lines, etc), Oil related (petroleum companies), medical (Vaccine, marijuana etc) and many other industries.
• Consider investing in different categories like Cryptocurrencies, Stocks, Indexes, FOREX, EFTs and commodities.
• Money management is an important part of diversification.
• For example, if you have different assets which are not correlated but invested 90% of your portfolio in the Technology industry then your diversification is not perfect.
• Try to introduce a limit for each category in your portfolio. 
• Do not put all the eggs in one basket. Diversify your portfolio as much as you can.

What to do when inflation is high

 Hi everyone!

Almost all of the Reserve banks worldwide are hiking the interest rates to fight inflation.

Now the question is: What is the correlation between inflation and the stock market?

To answer this question, we have to separate commodity-related stocks from others.

When inflation is high and the commodity price is going up, companies may lose money as the operating costs will go up and profit get less.

We are not going to get too technical by drawing graphs to compare inflation against an index.

This is done before by many other analysts.

The key is what to do in these situations?

There are some basics which we should follow.

1. Follow the trend. as much as you can. It is not always 100% possible to do this. You can see I have many red trades in stocks and cryptos. But if you check the history of my closed trades you will notice that I have closed many trades right before the big drops start. I have left the rest as I am thinking long term and you know the stock market has a cycle ( sometimes up to 5 or 7 years ). So, I am patient. I know eventually, my $NVTA or $RBLX stocks will go back up. 
2. Be patient if you do not pay fees to keep the open trades open! Yes, if your cryptos are not CFD you do not pay fees on long positions. One dayMy $SUSHI and $ALGO will go up.
3. As long as you see the commodity prices are rising keep some $OIL related trades open and enjoy the profit. I have OXY, DBO and ET positions going.

By Nina

Hedge Trading

What Is Hedging?

I call hedging a kind of insurance. Think about a bad event like a storm or flooding. We can not prevent a negative event from happening, but we can reduce the impact of the event by ensuring our asset. So, we can see the hedging every day. 

But in forex trading hedging means strategically using pairs in the market to offset the risk of any price movements in the opposite direction. In other words, forex traders hedge one position by another.

To do this you should know the correlation between different pairs.

Obviously, to open extra positions you will pay all the fees. No insurance is free, is it?

What are the negative points in hedge trading?

• In Forex, less risk means less income.
• Remember that you can not make money by hedging, It just helps you reduce your risk.

apadanaforex applies hedge trading on eToro. 

In sideways markets, we can do hedging on the same pair. Please do not do this in a very trendy market as you never know when the price will find its peaks. In the sideways market, we will make money on one and losing on the other one then we can close the profitable one at a point close to the peak and wait for the other one to either gets into profit or towards getting profitable. 

The other hedging scenario is looking for the pairs that are negatively correlating. For example, USD/CHF could be a good pair against EUR/USD. You can then close both trades when the total value is in profit.