Note: The article is authored by Jack Turner from the The Binary Advisor.
The Binary Advisor is a Binary Options trading portal. Offering expert analysis of the top binary options brokers, including financial news updates, technical and fundamental analysis for beginners and advanced traders alike
When trading in any capacity, whether it be trading stocks and bonds or trading binary options, the ultimate goal is to make as much money as humanly possible during any given trading session. To do so, traders employ several different types of strategies designed to minimize risk and maximize profits. One of the most common strategies used to maximize profits is the correlation strategy. Today, we’ll talk about what the correlation strategy is how it works, and give an example of the strategy in action. So, let’s get right to it…
What Is the Correlation Strategy
As mentioned above, the correlation strategy is a strategy that’s used by traders of all walks of life in order to expand profits earned from trading in the financial markets. The strategy runs on one basic fact… some assets are heavily correlated with each other in either a positive or negative way. Here’s how positive and negative correlations work…
Positive Correlation – Assets with a positive correlation general move in tandem with each other. This means that if the assets are positively correlated, when one moves up, the other follows and one moves down, the other drops in value as well.
Negative Correlation – Assets with a negative correlation have a tendency to move against each other. Therefore, when one asset is rising in value, it’s likely that the other asset is falling in value and vice versa.
Because the correlation strategy focuses on how assets move with or against each other it has an inherited ability to expand profits in a big way. After all, making one profitable trade is great, but if you were to find 3 or 4 assets that were correlated, you could triple or quadruple your earnings on the same exact trade.
Positive Correlation Example
One of the best examples of a positive correlation at the moment is gold and silver. Gold and silver have qualities that are very similar. You see gold and silver are both precious metals. So, they both are at the mercy of supply and demand, and supply and demand for the two tend to move in tandem with each other. Much of this movement has to do with market conditions. Because gold and silver are both precious metals, they are both considered to be safe haven investments. Therefore, when market conditions are poor, both gold and silver tend to rise in value. When market conditions are positive, both gold and silver tend to move lower in value. This is because as safe haven investments, investors look to precious metals as a way to keep their money safe during poor times in the market, causing increased demand. However, when market conditions are positive, investors build a heavier appetite for risk, leading to less demand for gold and silver as investors look to the market to make their money grow. Look at the chart below to see how heavily correlated gold and silver actually are.
Negative Correlation Example
Keeping in the mindset of precious metals, one of the best negative correlation examples I can give at the moment is the correlation we see between gold and the USD. When it comes to most commodities, the USD is the currency that’s used to form a value. Therefore, when the USD rises, the cost of commodities in nations outside of the United States rises. As a result, we tend to see weakening demand and ultimately weakening prices for commodities like gold.
Adversely, when the USD falls in value, the cost of gold outside of the United States also falls. This leads to higher demand for gold, and ultimately increasing gold prices. Below is a chart that compares the USD to gold in order to show how the negative correlation works.
To be a successful trader, it’s important to employ strategies that will help you to earn more with little extra effort. Using the correlation strategy will do just that. As you can see from the examples above, trading heavily correlated assets will help to expand your earnings each and every time you trade. So, what are you waiting for, it’s time to put this strategy to the test!