Trading in the Forex market can be quite challenging both for novice and experienced traders. Many strategies and systems have emerged in hopes of giving traders a higher chance of becoming profitable.
There’s this one topic that many have been curious about – the role of math in Forex trading.
In this article, we will talk about two approaches: how math should be used in forex, and how math may be used to your advantage.
Math should be used to determine your position sizing
It has always been said the size of the position you take in every trade is the most significant factor in building your equity. You should be able to assess your risk appetite – meaning, you have to determine how much you are ready to lose on every trade.
For example, you have $10,000 in your account. How much are you willing to risk per trade from that amount? It’s always been discussed that the recommended percentage is 1-2% per trade. So if it’s 1%, you’re willing to risk $100 per trade.
Now, let’s talk about determining your pip risk per trade. Pip risk is determined by the difference between the entry point and where you place your stop loss order. Let’s say you want to buy EUR/USD at 1.4015 and place a stop loss at 1.4025. The difference between the two is 10. That means the risk is 10 pips.
How math be used in trading?
Let’s talk about CORRELATION. Do you remember when your math teacher discussed correlation in school? Correlation is the numerical measure of the relationship between two variables. It can be positive, negative, or zero. Correlation can have value:
+1 is a perfect positive correlation
0 is no correlation
-1 is a perfect negative correlation
In Forex, currencies are always quoted in pairs. For example, EUR/USD, GBP/USD, and USD/JPY. Therefore, they are interlinked. Just like in math, the correlation between the pairs can either be positive, or negative.
It is positive when the two pairs flow in the same direction, and negative when the two pairs flow in the opposite direction.
Let’s give you a good example of a positive correlation:
EUR/USD and GBP/USD is an accurate example of a positive correlation. When EUR/USD is trading up, then GBP/USD is moving in the same direction, so your action for these two pairs would just be the same.
Now, let’s take a look at a negative correlation:
EUR/USD and USD/CHF have a negative correlation, therefore, if EUR/USD goes up upwards, then USD/CHF goes down. So, there would be no point to go short on both positions as they eventually cancel out each other.
Knowing the correlation of currency pairs can help Forex traders and investors make wiser trading decisions. But you have to understand that correlation in Forex can change due to different economic factors, so check and calculate the correlation of currencies from time to time.
Understanding the role of math in Forex trading can help reduce your risk. When you know how to use math in position sizing, you can reduce your risk. Same as when you know how to spot currency correlations.
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