Once you start your Forex trading training, you will notice that currencies are always quoted in pairs, one currency value against another. The price of the British Pound against the US Dollar, the Swiss Franc against the British Pound, the Canadian Dollar against the US Dollar and so on. Even from this set of three currency pairs you can see that some individual currencies appear more than once. When you learn Forex trading you will realize that this means that no single currency pair ever trades independently from others, they are all interlinked. This is called positive or negative correlation – positive when the pairs react in line and negative when they react opposite.
If you were trading the British Pound vs. the US Dollar you will also be partly trading the Euro vs. the British Pound. It stands to be true then that the British Pound vs. US Dollar trade must be correlated in some way to the Euro vs. the British Pound. Knowing which pairs move opposite and which move together is a useful tool for a trader, but can be hard to work out, particularly due to the fact that correlations can change.
When you learn Forex trading you will also notice that market sentiment and different economic factors are fluid and can change daily leading to swings in correlations between currency pairs. A strong positive correlation may turn out to be a negative correlation; equally, a correlation on the same pair could be different depending on the time frame of the trade you are looking at. A common correlation that forecasters and traders watch is the 6 month correlation, but these can be different to the correlation on your hourly chart.
What to do with your new correlation understanding?
Money management is the biggest tool in your trading tool box, and correlation and money management can go hand in hand. If you trade across multiple currency pairs frequently then you must be aware of correlations. If you are long on one currency pair and short on another, it could be that this trade is actually cancelling itself out because they are both correlated the same way. Equally if you are long and short on different pairs then you could be over leveraged on one currency pair without even realizing. During your initial Forex trading training, try and spot these changes in your demo account, it is the only way to get familiar with it.
It all comes down to exposure. Your understanding of currency correlations will help you keep your exposure to a level that your trading strategy and you are comfortable with. Remember, in trading it doesn't matter how well a single trade does. Your goal is to not prove every trade correct; it is to manage your account and grow your account. You will find that easier to do once you are aware of your total exposure in the markets.