Binary Options. Correlation
Correlation in the binary options trading
Have you ever noticed that many of the financial assets that are placed in your trading platform for trading binary options very often repeat the movement of each other? So that's what they do. Explanations for this phenomenon are as follows:
Many financial instruments are interconnected with the fundamental factors. For example, the foreign exchange market, i.e., currency, is very sensitive to changes in quotations of each other under the influence of macroeconomic news.
That is, if the news was released about the poor performance of the labor market in the euro area and the currency pair EURUSD starts to decline, then it is, in most cases, very sensitively influence GBPUSD pair, as the United Kingdom is also a member of the European Union and the exchange rate of GBP depends largely on the course of EUR. That is, the euro has rushed down, and pound sterling begins to move down after it.
In the market of goods the situation is nearly the same. And GOLD SILVER pair is also very dependent on each other. If the price of gold falls, silver quotes begin to move down too.
All the above mentioned can fit into a single definition - correlation
Correlation is a certain measure of mutual dependence of the two financial assets: currency pairs, indices, commodities and stocks. Thus, the size of the correlation coefficient is measured in the range of "- 1" to "+1".
If the correlation factor is close to "+1", it means that financial assets practically resemble the movement of each other. That is, they move in one direction repeating all the peaks and troughs in prices. Accordingly, if the correlation factor is about "-1", the financial assets are moving in the opposite directions. The coefficient of "0" is a complete difference between the line quotes of one tool to the other quotes. That is, they do not depend on each other and any similarity in their movement is just a coincidence.
In the screenshot above you can see the correlation table of quotations of currency pairs with the mapping coefficients in real time. There are calculators of correlation, indicators of correlation and correlation charts that show the relative similarity in the charts of different financial assets.
Why is it important to trade binary options?
Let's imagine that you have entered the transaction on 2 currency pairs AUDUSD and NZDUSD. In this case, both of these transactions were for purchase. What will happen? The correlation coefficient between these instruments is close to "+1", which means that these tools are moving almost simultaneously, and if you get a loss on the AUDUSD, then the same loss you'll get on the NZDUSD. The most logical thing was to make a deal on only one financial instrument, because why should you expose yourself to double jeopardy?
Thanks to such example simple rules are born:
- if the correlation coefficient between the two assets is close to "+1", then the transaction of binary options in the same direction on these instruments is impossible, as in the case of negative outcome you will get a double loss.
- if the correlation coefficient between the two assets is close to "-1", then the transaction of binary options in different directions on these instruments is impossible, as in the case of a negative forecast, we will get double loss.
Let's go on the reverse
If we should be afraid of a double loss on unidirectional transactions of financial assets which have a correlation coefficient close to "+1", then why do not we use this feature for our own benefit? That is, we can enter the divergent positions on assets with positive correlation in order to hedge risks. That is, bargaining on the AUDUSD for sale, that is, Put option, we need to strike a deal on the financial asset NZDUSD to buy, that is, Call option. Thus, if on one tool we received a loss, then the second is guaranteed to go out with a profit. It is clear that this strategy as it is will not bring profits, since the total amount of profit on the two transactions will have a negative value.
Let's say you made a deal to buy the AUDUSD, but the price has gone in reverse direction than it was expected. What should you do? Make a contract on the NZDUSD, but for sale. What will happen? Obtained on the NZDUSD profit will partially overlap the loss on the AUDUSD. That is, we deal on a hedging instrument, when we see that we get a deal on a guaranteed loss. At the same time, the second hedging order we must conclude at once, but only in those cases when we see that the first transaction will bring you a loss.
What tools are correlated?
As for the currency pairs, the correlation close to "+1" affects all financial assets with the same numerators, for example: AUDUSD, AUDNZD, AUDJPY, AUDCHF, AUDCAD, AUDSGD, etc., i.e, all currency pairs, where the first location is the same currency. Also, the currency pairs with a positive correlation coefficient, are all the pairs where the second currency is the same, for example: AUDUSD, NZDUSD, GBPUSD, EURUSD, and so on.
As for the goods, the positive correlation is always present on the energy resources, such as OIL and GAS, GOLD and SILVER metals etc.
Positively correlated stocks are stocks of companies of the same industry, such as IBM and Microsoft, as they are the producers of a number of similar products, automakers, airlines shares, etc. The same principles are applied to quotations indices that are very interrelated.
It is not necessary to use hedging, but the simple rules of trade on correlating tools always help to avoid additional losses and provide a more balanced attitude to take trading decisions and building trading strategies.