Correlation In Forex Trading and Profiting

by Iwan Whiteley

Looking on the internet at comments about forex trading, one wonders how people expect to make money without having a basic grasp of the principles involved in trading. People tend to rush in, with promises of easy money, but they then discover that it is a lot harder than it looks. This article seeks to identify a fundamental principle that leads to creating a successful trading model, it is founded on the idea of correlation.

Correlation exists where there is a mutual relationship of interdependence between two entities. Why is it that people feel so sure that they can earn money in forex? Surely the reason is that they immediately see that there are patterns, that is, correlation in the graph that can be exploited to make money. For example, consider AUDUSD (15 mins, 19th March) in the graph below:

We can see that there is correlation between the graph and the yellow line and is is tempting to think that, as a consequence this can be easily traded. The problem is that there are too many unknowns. How could anyone foresee that the price would bounce off of this line? How can we know how high the price will bounce off the line? How can we tell when the price will stop bouncing?

I would suggest that the reason that the majority lose money in currency trading is that although there is correlation in the graphs, yet people fail to realize that the nature of the correlation is very complicated. There is not only a relationship of interdependence between the price and the line on the graph above. Below is the graph with the inclusion of the stochastic (5, 3, 3) oscillator:

We can see that there is correlation between these two graphs. Although the price doesn't move directly proportional to the stochastic graph, yet the former generally turns at similar times to the latter. The result is that we have another tool to contribute to our understanding of how the price moves.

I would suggest that this is the nature of currency trading; it involves the accumulation of indicators that correlate with the price and as a consequence contribute to creating a successful trading method.

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