At this point you’re probably wondering, why are currency pairs (like the EUR/USD and USD/CHF) correlated in the first place? What causes these positive and negative relationships to exist?
Well much like our temperature and ice cream and temperature and clothing examples from before, currency correlations come down to basic fundamentals.
Increased temperatures are correlated to increased ice cream sales and decreased temperatures are correlated to increased clothing volume for two simple but extremely powerful FUNDAMENTAL FACTORS: comfort and survival.
People eat ice cream when it gets hot because it makes them comfortable, and they wear more clothing when it gets cold for the same reason…comfort (and in some cases survival).
The point is, the factors that drive these correlations are deeply rooted in daily life. They won’t change! Not this year…not in 10 years…NOT IN 100 YEARS!
The fundamentals behind these correlations are UNIVERSAL!
The same is true for correlated currency pairs…
There are literally dozens of correlated currency pairs, but what follows is a partial list of some of the most significant pairs, and the fundamentals that back them:
The EUR/USD and GBP/USD, for example, are positively correlated because the base currencies (i.e. the first currencies listed) of these pairs – the EUR and the GBP – represent European Union Member States, so they’re very, very similar both from a monetary policy and from a geographical sense.
In other words, when EU makes a shift in monetary policy or when there’s a major change in the European economy, both the EUR and the GBP are affected in the same way, because they’re both European currencies.
To be continued...
