Understanding Forex correlations.

A big part of my trading strategy is understanding the correlations currencies have with the risk environment and each other. Very often, the overall ‘risk environment’ dominates market movement. And the mood is classed as either ‘risk on’ (positive) ‘risk off’ (negative)... or neutral. When sentiment is strong in a particular direction, the currencies (generally) react in a certain manner. When the market is ‘risk on’, a good rule of thumb is…. Strong: AUD NZD GBP CAD Weak: JPY CHF USD EUR When there is fear in the market and sentiment is ‘risk off’, the exact opposite can (generally) be expected. Strong: JPY CHF USD EUR Week: AUD NZD GBP CAD There are caveats, such as the USD and EUR can sometimes behave as ‘risk on’ currencies (strong in a positive environment). The CAD can also be tricky sometimes as it often tracks the USD (due to geographical proximity). Plus the CAD can often be moved by its own correlation with the price of oil. But the above information is a good grounding point to start your own research into correlations and the risk environment. Two instruments that can help when gauging market sentiment are: The S&P 500, if stocks are going up, the mood is (generally) positive. The VIX, as a basic rule, if the VIX is falling, the mood is positive, or at worst ‘neutral’. Below 20 is seen as good for sentiment. But the higher above 20 the VIX goes, the more ‘fear’ there is in the market.