Once you understand how currency pairs are put together, the next step is to look at how to trade cross currency correlations.
Key is your awareness of how Forex crosses are traded by the main Banks and the interrelationship between specific pairs. Once understood how you should trade these pairs, and use the correlations to your own advantage, particularly in terms of short term trading / scalping, needs to be made.
In this video we look at the symbiotic relationship between groups of currency pairs and how this relationship affects the movement of the pairs in the open market and, by extension, you chance of making a successful trade.
The importance of cross currency correlations in scalping
Particularly if you are scalping the effect that one interlinked pair can have on another is considerable. Each pair is part of a triumvirate of pairs whose movement impacts on each other. If you are in a short term trade, entering the market for just a few minutes, looking for 7-15 pips, then the effect can be considerable.
How to trade cross currency correlations
For example, if you were to look to trade USD/JPY short and both EUR/USD and EUR/JPY were at resistance then there is a good chance that USD/JPY will remain flat making it difficult to make any profit. If on the other hand you wanted to trade EUR/JPY long and both EUR/USD and USD/JPY were moving up without any resistance then EUR/JPY would fly up, the reason being that EUR is being bought and JPY is being sold in the parental pairs movement.
The video shows a map of how the interrelationship between three different triumvirates can play out in the market. When you are initially getting to grips with how this relationship works it can be useful to have this in front of you (you can download the PDF below, we suggest you pint it out and keep it close to your trading monitor).
Assessing other cross currency correlations
Of course this is only three sets of triumvirate pairs, although probably the most important to know. There are obviously many more such as AUD/USD, EUR/USD and EUR/AUD.
One thing to bear in mind though is that obviously volume will play a role. On less heavily traded crosses one of parental pairs can tend to dominate and skew the effect.
At the end of the day nothing can beat experience. It is useful to group the triumvirates together on your platform (something that can be easily done with the TimeLanes) and just spend some time watching what is happening and seeing the relationships play out in a live market.
In the third part of this series on Forex cross pairs we will look at this relationship in real time as well as consider other factors such as time of day that can influence how these pairs react with each other.