The use of the correlation strategy is very important when finding the correct entry point to make a trade. There are some assets within the binary options market which share a correlation with another asset, and this correlation assists in making a prediction for one asset’s movement when based on the performance of the other. Its success is entirely dependent on the ability of the trader to recognise the trend, form the correlation and place a successful trade.
Correlation relates to the similarity before the performance and trend of two datasets. If there is a stronger correspondence between the assets, the better the chances of a system being successful in predicting the trend of the market. Correlation strategy is a secondary, complementary strategy to use in combination with another strategy and there are both negative and positive correlations in the market. Frequently, the market will trend with two assets in the same direction, and this is a positive correlation, however conversely there are also negative correlations in which the two assets’ prices will move in opposing directions.
When applying correlation strategy, a trader should divide their trade into 2 segments to minimise risk and make a gain from whichever asset moves most.
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Pair Options in Correlation Strategy
Pair options are a relatively recent introduction to the binary options market and it is designed to exploit the advantages of correlation. When trading pair options, a trade can appreciate on the correlated assets’ relative performance. One trade is activated which enables the trader to know about the other one, allowing the trader to make the best possible strategy to make the biggest profit. The correlation estimate relates to a specific period, exposing the degree and direction in which both variables are associated. However this relationship will change over time so the trader must review their strategy continuously.
The correlation coefficient strategy requires a trader to appreciate movements in the direction of highly correlated assets. Once a trend has been identified, a trader can achieve success in their trades. This strategy also gives the chance to make a profit whatever the direction of the market.
What are the Benefits and Disadvantages of Correlation Strategy?
One advantage of this strategy is that a trader can make a prediction about trends once the relationships are recognised. When two assets have a correlation, it is easy to make predictions about one based on the other. This strategy can be applied to both binary options and forex as well as virtually every other financial asset. Correlation produces key values which assist in predict asset price relationships which in turn inform trade executions. Traders can therefore form associations between different assets, determine their relationship’s direction and make a trade based on the information represented.
Correlation strategy also gives the trader a way of identifying new opportunities for trade by determining deviation between the associated assets. Traders can obtain the long term direction on their chosen assets and look out for good trade entry spots in order to benefit.
There are, however, some drawbacks. As this is not an independent strategy, it cannot be used on its own to form analysis and place trades. Another tool or method must be used in conjunction with it in order for it to be used successfully.
Once correlation strategy has been thoroughly understood, it can produce a rate of success of up to 90%, therefore it is a useful tool for maximising profits when forex or binary options trading when an experienced trader exploits it to its full potential in order to determine when to execute a trade.
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- An anatomy of trading strategies. Conrad, J. and Kaul, G., 1998. Review of Financial studies, 11(3), pp.489-519.
- “The price dynamics of common trading strategies.” Farmer, J. Doyne, and Shareen Joshi. Journal of Economic Behavior & Organization 49, no. 2 (2002): 149-171.