What is correlation in trading?
In one line: Correlation measures how closely two markets move together, on a scale from −1 (opposite) through 0 (unrelated) to +1 (in step).
The scale
- +1: the two move in step. One goes up, so does the other.
- 0: no clear link.
- −1: they move in opposite directions.
Most real pairs of markets sit somewhere in between, and the number changes over time.
A simple example
EUR/USD and GBP/USD have often moved in the same direction, because both are priced against the US dollar. When the dollar weakens, both pairs tend to rise.
Say you buy both, risking 1% on each. On paper that's two trades. In practice, if the dollar suddenly strengthens, both may hit their stops together. Your real risk is closer to 2% on one idea: "the dollar will weaken."
Now look at EUR/USD and USD/CHF. They've often moved in opposite directions, since the dollar sits on different sides of each pair. Buying both can cancel much of your exposure.
Why it matters
Correlation is how a careful risk plan quietly turns into a big one. Five trades in five tech stocks can behave like one large tech trade.
Checking it helps you:
- Keep total risk where you meant it to be.
- Avoid stacking trades that are really one bet.
- Understand Diversification and Hedging, which both rely on it.
More on keeping total risk small in how much to risk per trade.
A common mistake
Thinking correlation is fixed. Markets that moved together last year may not this year. In a sudden panic, many markets that usually move separately can fall together. Correlations tend to rise exactly when you'd most want them low.
Before opening a second trade, ask: "If the first one hits its stop, would this one probably hit its stop too?" If yes, treat them as one trade and split the risk.
Questions
Does correlation mean one market causes the other to move?
No. Two markets can move together because something else drives both, like the US dollar or interest rates.
How do you check correlation?
Many platforms, including TradingView, have a correlation coefficient indicator. You can also simply overlay two charts and compare.
What is a good correlation for diversification?
Lower is better for spreading risk. Holdings near 0, or below, tend to smooth out swings more than ones near +1.
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