How to Use a Currency Strength Meter

If you could choose one special power, what would it be?

For me, I’d opt for the ability to know — well, certain things.

In the stock and forex market, special knowledge can make you a millionaire. Consider knowing that GameStop stock would skyrocket to over $300 a share back when it was under $4. 💰

However, even if you can’t know exactly what a stock or currency position will do, there are still some helpful things you can do. The first of which, is knowing what it’s doing now. 

The tricky thing about forex is that it primarily measures a pair’s relationship to each other. You know how a currency is doing in relation to another currency—but that could happen for a few different reasons. Sometimes, it’s valuable to know what a currency is doing in itself.

That’s where the currency strength meter comes in! This is a way for you to measure a currency’s strength without comparing it to another currency. 

If you want to see how the dollar slumped to multi-month lows in May of 2021, this might be the tool for you. This guide will help you understand what a currency strength meter is, how it works, how to use it in your trading, and the do’s and don’ts for how to use one.

Ready? Let’s dive in! 🚀

What you’ll learn

• What is a Currency Strength Meter?
• Modern CSM: Forex Correlation Matrix
• How a Currency Strength Meter Works
• Reading a Currency Strength Meter
• Trading with a Currency Strength Meter
• Advantages
• Disadvantages
• Helpful Tips
• Conclusion
• Get Started with a Forex Broker

What is a Currency Strength Meter? 🔎

Unless you’re just learning what forex trading is, you probably know that positions in forex are made up of a pair of currencies. For example, you might be trading USD/JPY, a pair made up of the US Dollar and the Japanese Yen. 

Say USD/JPY does really well one day. First of all: hooray! But second of all, how do you know what actually happened to make your position go up? Is it because USD is doing really well, or because JPY is falling? 

The currency strength meter attempts to solve this problem. Essentially, the CSM shows which currencies are strong and which are weak. They do this by aggregating the exchange rates of many pairs, weighting these metrics, and then displaying the comparative strength of currencies.

Now, don’t stop reading just because we said “aggregating!” There’s some math magic going on behind the seasons, but the currency strength meter is easy to use. For example, say you wanted to track the Argentine peso after their record $3.2 billion earnings in May 2021. 

The CSM (that’s what we call our old pal the currency strength meter) would look at the strength of all pairs containing ARS (ARS/USD, ARS/EUR, etc), and then from there, it would figure out the value of the ARS itself. 

Modern CSM: Forex Correlation Matrix ⚡️

Over time, the currency strength meter has morphed into something called the forex correlation matrix. These can give information that’s more complicated than the currency strength meter, but also more accurate. 

Forex correlation refers to two currency pairs that are correlated. (Well, duh!) Specifically, forex correlation can be measured with a coefficient between -1 and +1. A -1 correlation means the two pairs will move in the opposite direction 100% of the time. If Currency XYZ goes down 5 points, Currency ABC will go up 5 points. 

A correlation of +1 means they will move in the same direction 100% of the time: If Currency XYZ goes down 5 points, Currency ABC goes down 5 points. (Sorry, Currency ABC).

And of course, there’s plenty of room in between -1 and +1. Different currency pairs might have stronger or weaker correlation. These correlations can be used to measure how strong the individual currencies are. 

For example, if the pair XYZ/ABC and ABC/PQR had a negative correlation, that means they move in opposite directions. ABC is the quote currency in the first pair and the base currency in the second pair: so a long trade on the first pair expects ABC to get weaker, while a long trade on the second pair expects ABC to get stronger.

Now, we know that the two pairs have a negative correlation. We can guess that ABC is causing this negative correlation. It’s therefore probably a stronger currency than XYZ or PQR. Correlation, therefore, helps us understand currency strength and vice versa!

How Does a Currency Strength Meter Work? 🏗

The forex correlation matrix is the best indicator of currency strength, and it’s a great idea to get comfortable reading it. If you’re starting to get comfortable reading forex charts, it’s a great time to learn how currency strength meters work as well! 

Basically, these work by creating a table of correlations between many pairs of currencies. You’ll be able to look across the row and see one currency’s correlation with other major currencies. Then, there are more rows with more currencies, so you can find correlations between specific pairs. 

But enough of the basic setup of the table. Perhaps you saw when France administered 2.5 million vaccine doses in a single week, and you want to know how that’s impacting EUR pairs. Let’s work on reading this chart.

How to Read a Currency Strength Meter 📚

Now, first, you’re probably seeing a whole lot of colors. Each of the colors shows you the strength of the correlation between the pairs. The colors break down as: 

• Green: Little to no correlation
• Blue: Weak correlation
• Orange: Medium correlation
• Red: High correlation

Green positions that are either positive or negative will generally move independently of each other. Blue squares under 30 will likely still move independently, though you may see correlated movement in ranges from 30-49.

Once you get into orange, you start to see more confident correlations. If you’re on a positive orange square, that means positions in the same direction will likely have similar profits, and positions in opposite directions will cancel each other out. Negative orange squares are the opposite: opposite positions will have similar profits, while similar positions will have similar profits. 

Red squares indicate a strong correlation. This has the same implications as the orange squares, but it’s more likely that your positions will correlate in the red squares. 

Remember, positive correlation means that they move in a similar direction, while negative correlation means they move in opposite directions. Positive or negative are NOT indicated by the color of the squares! See those little pluses and minuses next to the numbers? That’s what’s telling you whether the correlation is positive or negative.

So, how does all this add up to us telling the strength of a specific currency? Say you wanted to know the strength of USD while you were waiting for the Fed to publish their minutes. Well, you could look at the correlation between CAD/USD and USD/EUR. If they have a strong negative correlation, that means USD is likely in good shape. 

How to Trade Using a Currency Strength Meter 💱

We’ve gone through the tables: now you’re ready to turn these into strategies for trading forex! There are a few ways that using a currency strength meter can help you make smarter trading decisions. 

First of all, know that these correlations change. You’ll need to update your table regularly, especially if you are making fast-paced trades in strategies like scalping. Don’t be a dinosaur who prints out the table and looks at one version as the steadfast rule of currencies! 

Then, a correlation matrix can help you avoid positions that are just going to cancel each other out. If you have two positions that move in opposite directions, it’s a little silly to have long positions on both of those. You’ll always be mourning your losses at the party to celebrate the successes. 

You can also mitigate risk. If you feel strongly about a certain currency, and it’s treating you well, you can diversify by opening a position on a pair that correlates positively with the pair that you know and love.

Finally, you can use this to figure out how to hedge your losses when needed. If you expect a pair of yours is going to take a temporary dive, but you don’t want to close the position—maybe because indices were testing 3-month lows at the time—you can use the matrix to find a currency pair with a strong negative correlation. Then when your beloved position loses value, you’ll be making money on the negatively correlated position. 

Benefits of Using a Currency Strength Meter 🎯

There are a whole bunch of ways using a currency strength meter can help you up your game in forex trading. After all, with more business influencers turning to forex, you have to keep your edge somehow.

Free & Simple ✔️

Who doesn’t love free stuff? You can get good currency strength meters for free, and they are easy to understand. We’ve gone into the weeds on how the table is created, but all you really need to know is how to read it. And you’ve even got pretty colors to help you.

Know Currency’s Strength ✔️

If you want to know how a currency is doing in the short term, the currency strength meter can help you out. This will show you what the up-and-coming currencies are, which may help you get in on the ground floor. Just note that these provide a snapshot of the forex market—so always check the most up-to-date version of the table before making a trade.

Stop Double Exposure ✔️

Now, you might want to invest in positions that are highly correlated—if you think they’re extremely dependable. On the other hand, you might want to diversify your portfolio by investing in things that will respond to different fluctuations in the market. 

Sure, in May 2021 we experienced a spike in commodity prices, so we’d all love to have ten positions correlated with those commodities. But when the price point comes back down? We don’t want those magnified losses.

Stop Accidentally Hedging ✔️

If you need to hedge your bets—go for it. But don’t accidentally open a position that’s going to cancel out one of your other positions. That’s just silly. Before opening a new position, check that it’s not strongly negatively correlated with one of your existing positions. 

Drawbacks of Using a Currency Strength Meter ⚠️

There are some currency strength meters on the market that might have you fantasizing about throwing your computer monitor on the ground. (Don’t do it!)

Some meters are more accurate than others. Obviously, an inaccurate meter is completely useless. Some might also give you filters on top of the currency strength—which could lead to false or misleading information.

Then, there’s just the technical issues that could arise. You might also have freezes, stutters, and poor memory with some of the older models. You might realize that it’s forcing your CPU to work at 100% constantly.

Note that most of these issues are with downloadable currency strength meters. A correlation matrix is unlikely to have these issues, especially if it was made with newer technologies. 

Tips for Using a Currency Strength Meter ✅

You’re almost ready to go and start trading with your currency strength meter! Here are a few last-minute tips that we want to send you on your way with.

• Use a currency correlation matrix to calculate currency strength.
• Check correlations before opening a new position. Make sure you want to double your exposure before opening a position on a positively correlated pair or hedge your losses before opening a position on a negatively correlated pair.
• For scalping, you’ll probably want to update every five minutes and show 50 bars on the table.
• For intraday trading, go with hourly updates and 200 bars. 
• For intraweek swing trading, you’ll probably want hourly updates on 500 bars.

And finally, you can always test out your meter without the risk! Most of the top forex brokers will offer demo trading accounts where you can practice using the currency strength meter and see how it would affect your trades.

Where Can I Find a Free Currency Strength Meter? 🗺

Many forex brokers will provide online resources in their trading software. These almost always include a currency strength meter that can be used in their charting software. So check your broker first! There are also third-party software options that offer currency strength meters online.

Conclusion 🏁

So, are you ready now to go make big bets on the next 100 sports games? Maybe not. But, you can quickly analyze how your positions and potential positions relate to each other. Plus, you can compare correlations to check out how an individual currency is doing outside of any one specific pair. 

Currency strength meters are definitely built from complicated math, but they’re not complicated to use. Don’t let a chart full of numbers scare you off! If you’ve made it to the end of this article—and this section is titled “Conclusion,” so you know you have—you know everything you need to know in order to start trading with your old pal the CSM. So don’t be afraid to try it out.

Get Started with a Forex Broker

About the author

Tim Fries

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Tim Fries is the cofounder of The Tokenist. He has a B. Sc. in Mechanical Engineering from the University of Michigan, and an MBA from the University of Chicago Booth School of Business. Tim served as a Senior Associate on the investment team at RW Baird's US Private Equity division, and is also the co-founder of Protective Technologies Capital, an investment firm specializing in sensing, protection and control solutions.