One of most important relationships to understand in the forex market is the one between the Swiss franc and euro. There is a very strong correlation between these two, meaning that the Swiss franc tends to rise against the US dollar when the euro does. Because of this, the EUR/ USD and USD/CHF currency pairs are strongly negatively correlated – the correlation can be as strong as -95%. In other words, when one currency pair rises, the other currency pair almost inevitably falls. Keep in mind that the two currency pairs run in opposite directions – if a CHF/ USD currency pair were used instead, both EUR/USD and CHF/USD would move together in the same direction nearly all of the time.
There are two main reasons for this correlation. First of all, the US dollar is the world’s top currency, and the US economy is also the largest. This means that the US dollar is involved in 90% of all currency trades, and the state of the US economy has a major impact on other economies around the world. This means that money tends to flow into and out of the US dollar, impacting all other currencies to some extent. Because of this, there is generally at least 50% or more correlation between currency pairs that involve the US dollar – the strength of the US dollar alone tends to overwhelm any particular strengths and weaknesses in other currencies when setting exchange rates.
However, the relationship between the Swiss franc and euro is even stronger than this. This is because Switzerland is situated directly in the middle of the eurozone, even though it is not part of it. Both the close physical proximity and strong trade ties tend to create a much stronger correlation between the two currencies than is found with other currencies. For example, strong growth in the eurozone translates into strong growth in Switzerland – creating similar upward pressure on both currencies.
Understanding this relationship is very important when managing risk. For instance, if you take a short position in USD/CHF and a long one in the EUR/USD, you are essentially doubling your risk. If the two currency pairs weren’t strongly correlated, then they could rise and fall independently. However, the correlation means that you will gain or lose on both positions at the same time – compounding your losses or profits.
In general, it is not a good idea because of this to trade both pairs. Some inexperienced traders also think that they can use differences in interest rates to carry out arbitrage with these two pairs – for example, going long on both currency pairs so that the risk is zero, and then pocketing the interest differences between the two pairs. However, for various reasons this often doesn’t work, particularly because the correlation is not perfect – the two currencies can decouple at times due to local economic and political factors.
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Editors’ Picks
AUD/USD: The hunt for the 0.7000 hurdle
AUD/USD quickly left behind Wednesday’s strong pullback and rose markedly past the 0.6900 barrier on Thursday, boosted by news of fresh stimulus in China as well as renewed weakness in the US Dollar.
EUR/USD refocuses its attention to 1.1200 and above
Rising appetite for the risk-associated assets, the offered stance in the Greenback and Chinese stimulus all contributed to the resurgence of the upside momentum in EUR/USD, which managed to retest the 1.1190 zone on Thursday.
Gold holding at higher ground at around $2,670
Gold breaks to new high of $2,673 on Thursday. Falling interest rates globally, intensifying geopolitical conflicts and heightened Fed easing bets are the main factors.
Bitcoin displays bullish signals amid supportive macroeconomic developments and growing institutional demand
Bitcoin (BTC) trades slightly up, around $64,000 on Thursday, following a rejection from the upper consolidation level of $64,700 the previous day. BTC’s price has been consolidating between $62,000 and $64,700 for the past week.
RBA widely expected to keep key interest rate unchanged amid persisting price pressures
The Reserve Bank of Australia is likely to continue bucking the trend adopted by major central banks of the dovish policy pivot, opting to maintain the policy for the seventh consecutive meeting on Tuesday.
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