As far as Forex trading is concerned, there exists one relationship between currencies of which every Forex trader should know before actually to start trading. It is the correlation between Swiss franc and euro currency pairs – the relationship extremely strong to ignore. According to the Forex market studies, it becomes obvious that the correlation between these currency pairs may be negative 95%. It is called a contrary relationship meaning that – by and large – in case EUR/USD gains in value, USD/CHF loses value in general. The opposite is also truth.
It is generally known that during the longer periods of time, like one year, the majority of currencies traded against the US dollar have over 50% correlation. It happens since the US dollar is a leading currency included in 90% of Forex transactions. Though the strong correlation between USD/CHF and EUR/USD occurs partly thanks to the general dollar impact in the two currency pairs, the explanation why the relations are much stronger than in other currency pairs comes from the tight links between Switzerland the Eurozone.
Switzerland borders on other Eurozone countries and, as a result, enjoys very close economic and political links with its bigger neighbors. The agreements between Switzerland and the Eurozone signed in 1972 and in addition to more than a hundred further mutual agreements that followed later enabled the free influx of Swiss citizens into the labor force of the EU as well as the slow but sure opening of the Switzerland employment market to citizens of the European Union. However, the links do not finish at this point. 60% of Swiss export is intended for the Eurozone, and 80% of imports are from the European Union.
As far as Forex trading is concerned, if EUR/USD and USD/CHF are long, two strongly offsetting positions are obtained or, on the whole, EUR/CHF. In the meantime, if one currency pair is long and another one is short, the same position is actually doubled up, albeit it can look like two different Forex trades. It is essential to realize for the suitable risk management since if something is skewed when one currency pair is short and another is long, losses can be multiplied easily.
The relations between the USD/CHF and EUR/USD decouple when there are different political or fiscal policies. For instance, if elections cause insecurity in Europe while everything is all right and stable in Switzerland, EUR/USD can decrease more in value than USD/CHF increases. On the contrary, if the Eurozone lifts interest rates assertively and Switzerland does not, EUR/USD can gain in value more than USD/CHF loses in value. On the whole, the fact that ranges of the two currencies may diverge more or less than the point difference, is the main reason why interest rate arbitrage in the Forex market applying these two currency pairs doesn’t work. The ratio of the range is measured by dividing USD/CHF range by EUR/USD range.
Provided by A. Collins who is a creator of simple forex trading system which is available on Forexeasystems. Also you can find there mt4 plugin Fx Pulse which can automatically collects Forex market information and displays it directly on the trading chart in real time.
- Forex Education Defined (forextradingsystemcentral.com)