Introduction & Overview

Correlation is a statistical measure of the relationship between two financial instruments. This measure helps to reveal the interdependence that exist between financial instruments/securities. In the financial market, securities do not move in isolation. An understanding of this would help you to be a better trader because correlation when used to your advantage can be hugely beneficial, but many traders are oblivious of this fact.

In real life, you would agree with me that on a sunny day, an ice cream man would sell more than on a cold day. It therefore suffice to say that as the temperature increases, ice cream sale also increase. The sale of ice cream and temperature can be said to be positively correlated. This same principle also happen in the financial markets.

For example, over the years, EURUSD and USDCHF almost always move in opposite direction which means that with a good and reliable signal, a SELL order on EURUSD and a buy order on USDCHF placed at the same time would almost always result in a win if the correlation is high at the time of placing the order. Correlation does not only happen in Forex, it happens in Futures and Commodities as well and it is therefore important for traders to understand how it works and the benefits.

The Challenge Before Now

• Many websites offer correlation between Forex pairs only but do not offer correlation between say Forex instrument and a futures instrument or between a Forex instrument and a commodity instrument.
• Automating trading strategies that use the principle of correlation is difficult.
• Data from these websites may be slightly different from your broker.
• Correlation cannot be tracked in real time in metaTrader 4.

Advantages of Using Correlation

To be successful in financial trading, you need to be able to manage risk, and a good understanding of how correlation works helps you to do this effectively. Let's take a look at some of the advantages below:

• Diversification (Do not put all your eggs in one basket)

If you know that EURUSD and GBPUSD almost always move in the same direction and you forecast a weakness in USD, instead of buying 2 lots of EURUSD, you can buy 1 lot of EURUSD and 1 lot of GBPUSD.

If a news release causes a weakness in EUR and therefore sends your buy position on EURUSD into a losing position, it is very unlikely that your GBPUSD position would result in a loss as the news release would not have the same impact on GBPUSD.

• Hedging (Reduce risk to the barest minimum)
• Maximize winning opportunities

You know that USDCHF and EURUSD move in opposite direction. Suppose that you are LONG on EURUSD and SHORT on USDCHF at the same time. If you win on EURUSD, it's almost certain you will win on USDCHF.

For more information on these advantages, take a look at the Comments tab.

Benefits of Verdure Correlation Pro

• You can display correlation between any two instruments on any chart in metaTrader 4. For example, you can display correlation between XAUUSD and AUDUSD on EURUSD chart.
• Track changes in correlation between any two instruments in real time right on any chart in metaTrader 4.
• Generate alert, notification or email on correlation co-efficient reaching or dropping below a set threshold.
• Highly accurate values because data used in the calculation is that of your broker.
• Access to the past behaviour of correlation between two instruments because correlation value is presented using a line graph. This is quite useful for research.
• Automation in EA is facilitated by obtaining correlation value using iCustom function (see INDICATOR BUFFER section).

Interpretation of Correlation values

Values are calculated and displayed from -100 to +100.

• If the calculated correlation value is above 80 and positive (+80 to +100), the securities move in the same direction.
• If the calculated correlation value is above 80 and negative (-80 to -100), the securities move in opposite direction.

This simply means that if calculated correlation value for EURUSD and USDCHF is say -95, for every 100 bars, the 2 instruments moved in opposite direction 95 times. If you therefore place a BUY order for EURUSD and at the same time place a SELL order for USDCHF, you have a 95% chance of winning the 2 positions.
A more detailed interpretation is given below:

• +100 - perfect positive correlation
• +80 - strong positive correlation
• +60 - moderate positive correlation
• +40 - weak positive correlation
• +20 - very weak (insignificant) positive correlation
• 0 - no correlation whatsoever
• -20 - very weak (insignificant) negative correlation
• -40 - weak negative correlation
• -60 - moderate negative correlation
• -80 - strong negative correlation
• -100 - perfect negative correlation

Few Examples of Correlation in the Forex

Pull up your chart and take a look.

• EURUSD and USDCHF (Negative Correlation)
• EURUSD and GBPUSD (Positive Correlation)
• AUDUSD and NZDUSD (Positive Correlation)
• Oil and USDCAD (Negative Correlation)
• Oil and CADJPY (Positive Correlation)

Note: Correlation value differs from timeframe to timeframe, so be aware. If you trade on M15 chart, use correlation data for M15.

Input Parameters

• SymbolA - the first financial instrument
• SymbolB - the second financial instrument
• CorPeriod - correlation period (from 1 to 500)
• LineColour - colour of the indicator Line
• UpperThreshold - Upper Threshold level
• LowerThreshold - Lower Threshold level
• EmailonThresholdBreach - send email to email address configured in MT4
• alertonThresholdBreach - display and sound alert
• NotifyonThresholdBreach - push notification to the mobile terminal

Indicator Buffer

Buffer 0 - Correlation Value

If you are really keen on taking advantage of the great opportunities presented by using correlation in your trading, see more information and resources in the Comments tab.