How I use TradingFloor's online FX Correlations tool for trading
TradingFloor.com’s free online trading tools are among the most popular features in this online trading community, or so my editors tell me. As an FX trader, I have used and continue to use these applications in practical everyday situations - but rather than run you through a dull and dry technical tutorial of how to use them, allow me to relay from personal experience how I do.
The first tool I’m going to look at is the FX Correlations tool. There are two versions of the tool – one using nodes and one using traditional bar charts, which you can access via the 'show details' arrow. Dragging the various colorful nodes around and visually seeing the relative correlation size can be of of great help,
though it ultimately comes down to whether you’re a visual or empirical person to determine which works best - bobbles or bars (bar charts). But the net effect/result should be the same, i.e. the ability to find some semblance of a relative value trade without getting sucked into the horrible risk on/off abyss.
Given how much has been made of the whole “risk on/off” dynamic that this market has been so wrapped up in over the last 18/24 months, I thought it most appropriate to have a look at what this genuinely translates to in real terms for the G7 pairs. I don’t run a whole manner of regression analysis, models, unmanned space flights etc. so having ready access to someone else having done the work for me is indeed very welcome.
Correlations with many variables
For instance, the FX correlations tool tells me that the USD will be sold against both the GBP and the AUD when risk is basking in its glorious popularity, however the pace and volume with which it’s sold against these two will vary depending on a number of variables, current positioning, upcoming data/risk events, current economic policy as related to recent retarded headline etc...This in of itself gives rise to the potential to trade the GBPAUD direct as a cross of its own merit.
Now whether you buy or sell it will depend on the above mentioned beta as well as a host of other variables mentioned. In an attempt to get a better grasp of which might be better (buy or sell) you can do one of two things:
- Sit glued to your screen for 16 hours a day watching and noting price action and reaction
- Use the FX correlation tool and examine correlations of the GBPUSD and the AUDUSD to the EURUSD which takes about 7 minutes.
I have spent near on 20 years employing the former method and I can assure you, I would much rather have lived a normal life and employed the latter method and likely achieved the same (if not better) results!
Using the tool to look at AUDUSD and Cable
Using the FX Correlations tool, I have been able (via the various legs) to gain a better understanding of when the AUDUSD and the Cable have been sitting at significant support levels and the EURUSD decided to fall out of bed on the day (because it could) there was a far greater likelihood that the AUDUSD would tumble far quicker and its “beta” would be far greater to the EURUSD move than that of the GBPUSD in the same instance.
Thus the favoured trade would be (given my loathing of trading direct USD legs in these instances) to buy GBPAUD, as the GBP holds, while the AUD joins its pillow talk buddy the EUR and both fall out of bed. How have I been able to determine this? Simple really, I took a closer look at the size of relative correlation of the AUDUSD (+0.573) to the EURUSD as compared to that of the GBPUSD (+0.4508) to the EURUSD and the numbers spoke for themselves.
Using the tool to figure out how to diversify
Citing another example of practical use of the FX correlations tool I have actually used it to gauge how to diversify out of USDJPY and associated BoJ intervention risk while still maintining my bias for a weaker JPY as part of somewhat rather convoluted safe haven flows.
The greatest single negative correlation to the USDJPY is by far and away the EURCHF (-0.4812). Having been able to see this relationship for what it really is, rather than guesstimating a close enough approximation I was able to keep my USDJPY shorts, while simultaneously diversifying (partially hedging against BoJ jawboning) by holding a long EURCHF position roughly half the nominal size of my USDJPY trade.
How do you use the FX Correlations tool? Answers on a postcard, or in the comment space below.