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
EUR/USD stays in positive territory above 1.0850 after US data
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EUR/USD clings to modest daily gains above 1.0850 in the second half of the day on Friday. The improving risk mood makes it difficult for the US Dollar to hold its ground after PCE inflation data, helping the pair edge higher ahead of the weekend.
GBP/USD stabilizes above 1.2850 as risk mood improves
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GBP/USD maintains recovery momentum and fluctuates above 1.2850 in the American session on Friday. The positive shift seen in risk mood doesn't allow the US Dollar to preserve its strength and supports the pair.
Gold rebounds above $2,380 as US yields stretch lower
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Following a quiet European session, Gold gathers bullish momentum and trades decisively higher on the day above $2,380. The benchmark 10-year US Treasury bond yield loses more than 1% on the day after US PCE inflation data, fuelling XAU/USD's upside.
Avalanche price sets for a rally following retest of key support level
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Avalanche (AVAX) price bounced off the $26.34 support level to trade at $27.95 as of Friday. Growing on-chain development activity indicates a potential bullish move in the coming days.
The election, Trump's Dollar policy, and the future of the Yen
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After an assassination attempt on former President Donald Trump and drop out of President Biden, Kamala Harris has been endorsed as the Democratic candidate to compete against Trump in the upcoming November US presidential election.
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