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How to increase profits by knowing correlation

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How to trade different assets without analysis

I want to discuss a binary options strategy using the correlation of assets, and you will realize that unlike the Martingale, which limits your risk, correlation increases your income while you don’t need to increase the size of the investment or do further analysis.

What is correlation?

Refresh your memory. The correlation of assets is the dependence between assets arising as the result of close causality. In other words, it is a direct or backlash reaction of assets for a fundamental factor. The correlation index ranges from -1 to +1. An index of -1 indicates the constant diverse movement of assets. For example, if the price of gold rises, the U.S. dollar falls automatically. If the correlation between assets is +1, this index indicates the assets’ identical motion.

For example, with the increase of gold prices, the Australian dollar rises. If the coefficient of the correlation between assets is 0, this indicates the absence of any connection between these assets and any temporary identical movement of the assets is fortuity.

There is the formula to determine the correlation coefficient between the assets:

r = ?i(xi–?x)(yi–?y)/n?x?y

Where n = pairs xiyi; ?x and ?у = standard deviations of х and у

Alternatively, you can calculate the correlation coefficient between the assets of binary options using Excel. Simply select the function "= CORREL (array1, array2)."

What assets are correlated?

Correlation of Currencies

It is worth noting that almost all the currency pairs correlate with each other, but with different indices. Direct correlation involves all assets that have the same base currency: EUR/USD, EUR/GBP, EUR/CAD, and currency pairs involved those that have the same quoted currency: AUD/USD, NZD/USD, GBP/USD, EUR/USD and so on.
Accordingly, an inverse correlation has, in the first case, base currency pairs and, in the second, quoted pairs, such as EUR/USD, USD/JPY.

Note that the pair may have a direct or inverse relationship, but at different rates. Therefore, in practice, three pairs can have a direct correlation, but the charts of just two currency pairs will be almost identical, and the chart of the third currency pair slightly different. Therefore, this binary options strategy requires good knowledge of assets correlation.

Correlation of commodities

Among the commodities traded on the stock exchange, direct correlations involve oil and gas, as well as gold and silver. The correlation index of gold and silver ranges between 0.80-0.95. As you can see, the index of the correlation is high, but the trade in the same direction of the assets can be only if you clearly know the future direction of gold prices. In the case of the simultaneous purchase CALL option on gold and silver, you risk a loss from the two options if the price goes in your favor.

Correlation of stocks

Stocks also have correlations. For example, stocks of companies that belong to the same industry have a direct connection. However, the stocks of one branch have weak correlation coefficients. If the price of the stocks of one company falls, for example, at the result of an oil spill or breakage towers, this doesn’t imply an automatic reduction of the stock price of another company from the same industry. High correlation indices have commodities and companies whose activities are based on the use of these commodities. If the world oil price falls, the stock price of BP, Chevron and Lukoil will decline.

Correlation of indices

There is a close correlation between the branch indices and stocks of companies that are part of the industry index. Also, there is a close correlation between commodities, stocks of companies whose activities are based on the use of this product and the index of the industry.

Correlation in practice

Knowing the index of the correlation between oil and the Canadian dollar, you can buy PUT options, USD/CAD, when the oil price goes down.

When gold goes down you can automatically buy CALL options of the U.S. dollar and PUT options of the Australian dollar and steadily increase profits.

As you can see, the binary options strategy using correlation is aimed primarily at increasing your profits. You only need to correctly predict the future price movement of the asset, and on the basis of its decision, make the relevant transaction.

Disclaimer: The article is written for informative purposes only and it is not financial advice. The author does not have any position in the currency pairs mentioned, and no plans to initiate a position. He wrote the article himself and expressed his own opinions. He has no business nor personal relationships with any mentioned government entities or stocks. Readers should not treat any opinion expressed by the author as a specific inducement to make a particular trade or follow a particular strategy, but only as an expression of his opinion.

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