Many currency pairs share a currency, so they move together. If you buy EUR/USD and GBP/USD at the same time, you haven't taken two trades; you've taken one bigger bet against the US dollar. Correlation measures how closely two pairs move, and ignoring it is one of the easiest ways to take far more risk than you planned.
The correlation coefficient
Correlation runs from +1 (always move together) through 0 (no relationship) to −1 (always move opposite). Above about +0.7 or below about −0.7 is usually treated as strong.
Why the patterns exist
- Shared currency: EUR/USD and GBP/USD both have USD as the quote, so a dollar move hits both.
- Mirror quotes: EUR/USD and USD/CHF put the dollar on opposite sides, so they move in opposite directions.
- Linked economies: Australia and New Zealand share trade and commodity exposure, so AUD/USD and NZD/USD move closely together.
Using correlation
| You hold | Adding this | Effect |
|---|---|---|
| Long EUR/USD | Long GBP/USD | Roughly doubles your dollar exposure |
| Long EUR/USD | Long USD/CHF | Largely cancels out; little net exposure |
| Long AUD/USD | Long NZD/USD | Close to doubling the same trade |
| Long EUR/USD | Long USD/JPY | Partly offsetting; weaker relationship |
A practical rule: treat strongly correlated positions as one trade for risk purposes. If your limit is 1% per idea, two highly correlated positions should share that 1%, not take 1% each.
Key takeaways
- Correlation runs from +1 (move together) to −1 (move opposite); beyond ±0.7 is usually strong.
- Pairs sharing a currency, or linked economies, tend to be strongly correlated.
- Treat highly correlated positions as one trade when sizing risk.
- Correlations change over time and can break down suddenly.