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Trading Strategies

If you are looking for trading ideas or are simply looking to enhance your current strategy, then you have come to the right place.

Introduction

Forex Basics

Risk Management and Trading Psychology

Forex Basics

Taking a Fundamental Approach to Forex Trading

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Trading the Euro with Germany ZEW Survey

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Trading the Swiss Franc with the Swiss Trade Balance

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Trading the US Dollar with the FOMC Minutes

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Suggested Strategies to trade the US dollar with this economic release:

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Trading the Yen with Japan Trade Balance

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Trading the Aussie with Australia Trade Balance

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Trading the Australian Dollar with THE RBA RATE DECISION

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Suggested Strategies to trade the Australian dollar with this economic release:

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Trading the Euro with Germany Trade Balance

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Trading the Euro with the ECB Rate Decision

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Suggested Strategies to trade the Euro with this economic release:

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Trading the Euro with the ESI

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Trading the Euro with the IFO Report

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Trading the Greenback with the US Trade Balance

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Trading the Kiwi with the New Zealand Trade Balance

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Trading the New Zealand Dollar with the RBNZ Rate Decision

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Trading the Sterling with the BOE Rate Decision

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Suggested Strategies to trade the British Pound with this economic release:

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Trading the Sterling with the UK Trade Balance

Forex Basics

Taking a Technical Approach to Forex Trading

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Types of Charts

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Chart Patterns

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Triangles and Trend lines

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Volume

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Indicators

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Optimize Your Forex Trading With Bollinger Bands

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Optimize your Forex Trading With the Moving Average

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Optimize Your Forex trading with the RSI

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Optimize Your Trading With the MAC-D

Forex Basics

Grid Trading - Concepts, Mathematics, and Money Management

Forex Basics

Understanding Forex Correlation Concepts and Their Effect on Trading

Forex Basics

How You Can Benefit From an ECN Broker

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Who uses an ECN Broker?

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Ways to Use an ECN Broker to Benefit Your Trading

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Overview of ECN Benefits

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Alternative to the ECN

Understanding Forex Correlation Concepts and Their Effect on Trading

What is "Correlation" Between Pairs?
When you are trading currency pairs in the Forex market, there would seem to be no end to the external forces that govern price movements. News, politics, interest rates, market direction, and economic conditions are all external factors you need to consider.

There is, however, an always-present internal force that affects some currency pairs that you need to be aware of. This force is correlation.

Correlation is the tendency of certain currency pairs to move in tandem with each other. Positive Correlation means that the pairs move in the same direction, Negative Correlation means that they move in opposite directions.

Correlation exists for a lot of complex reasons and because some currency pairs contain the same currency in their base pair as others contain in their cross pair, for example the EUR/USD and the USD/CHF. Because the Swiss economy tends to mirror Europe in general and because the US Dollar is on the opposite side of each of these pairs, their movements - to an extent - will mirror each other.

Correlation is actually the statistical term for the measurement for the tandem movement between any 2 currency pairs. A correlation coefficient of 1.0 means the pairs move exactly in tandem with each other; a correlation of -1.0 means the pairs move in exactly the opposite direction. Numbers between these extremes show the relative amount of correlation between a set of pairs. A coefficient of .26 would mean that the pairs have a slight positive correlation; a coefficient of 0 would mean that the pairs were perfectly independent of each other.

How can Correlation be used in Trading?
Now that we know that we can expect certain levels of in-tandem movement between certain pairs we can make more informed trading decisions, by creating hedges, diversifying risk in profitable positions, and avoiding positions with pairs whose correlation causes them to naturally "cancel" each other out.

Let's look at a method of diversifying risk using currency pair correlation.

Situation 1
Let's assume you believe the USD is set to rally. The obvious move would be to go short on the EUR/USD pair, but doing so places your outcome squarely in the movement of one pair. If you wanted to diversify your risk you could find a pair that has a positive correlation with EUR/USD and split your purchases between the 2 pairs. The AUD/USD has a very high - but not perfect - correlation with the EUR/USD. You might wish to split your position between the EUR/USD and the AUD/USD (which has a positive correlation of about .71). The positive correlation between the pairs allows you to profit from the movement of the USD while the lack of perfect correlation reduces your risk to spikes in either of the 2 pairs.

Situation 2
Understanding correlation allows you to avoid taking positions that (due to high negative correlation) will tend to cancel each other out. The EUR/USD and USD/CHF pairs we mentioned earlier are a good example. The pairs have a historical correlation coefficient of about -.90 meaning that they almost always move in opposite directions. Knowing this, a trader wouldn't go long on both pairs at the same time because the movement of one pair will cancel out the movement of the other.

Plausible Trading Strategy
A plausible trading strategy would be to trade 2 currency pairs based on their correlation's reversion to the mean. You can track the correlation of 2 currency pairs over time and if it gets away from the norm you can place a trade in the direction that will snap the correlation back to the mean. For example if the EUR/USD and the USD/CHF have a correlation of -.9 and the EUR/USD goes on a huge rally while the USD/CHF does not drop as quick you can go short EUR/USD and go short USD/CHF and look for the correlation to snap back to the mean as a result of EUR/USD dropping of the USD/CHF dropping in order to revert the correlation to the historical mean. Of course keep in mind that the correlation is not stagnant and there is no guarantee that it will always revert.

Correlation can Change
The correlation ratios of pairs are not static. Changes in economic conditions, interest rates, or government policies can cause currency pairs to change over time. Just as prices move fluidly so does correlation.

Conclusion
Currency pair correlation is an underlying gravity in the Forex universe. Knowing that it exists (and changes) gives the trader a powerful tool to use with many trading systems or to implement in a standalone system.

Forex Strategy Section    ECN Brokers
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