Switzerland enjoys the status of being one of the richest countries in the world. In March 2001 the country rejected accession to the EU despite the fact that its economic policies and practices are generally in line with those of the EU. Therefore, for the time being the Swiss Franc remains one of the most actively traded currencies with two major characteristics that are important to us as forex traders.
Despite the fact that its status has fallen somewhat in recent years, the Swiss Franc has historically been thought of as one of the world’s main safe haven currencies, which means that money flows into the Swiss Franc during times of economic or geopolitical uncertainty. The main reasons for this are:
The Swiss Franc is not backed by gold anymore following the Swiss governments decision to sell the country’s large gold reserves in 2005. It is argued by some that this has had the effect of the Swiss Franc losing its status as a safe haven, but this will become clearer in later years when this argument has been put under test.
Another thing that it is key for traders to comprehend with regards to the Swiss Franc, is its strong correlation with the Euro. Due to the fact that the Swiss Franc is quoted on the opposing side of the Dollar when compared to the Euro, this translates as the USD/CHF currency pair having a strong negative correlation with the EUR/USD currency pair.
The chart of the two currency pairs shows a strong negative correlation of over 90% between the two currency pairs, which is a result of the strong economic links between Switzerland and the European Union.
The principal reason that it is important for traders to understand this strong negative correlation, is in order to be able to take it into account when considering trades in both currency pairs. As both currency pairs have such a high negative correlation, there is a very good chance that a trader’s technical analysis will lead to a buy signal in the EUR/USD, while at the same time leading to a sell signal USD/CHF, or vice versa.
If this trader was unaware of the negative correlation we have just described, they might think that they are placing two completely different trades. As we have outlined though, what this trader would actually be doing is doubling their exposure to the move they were attempting to capture. On the other hand, should a trader trade these pairs in the same manner, then they would effectively be decreasing the effect of both trades, as the negative correlation between the two currency pairs would offset any gains or losses that were achieved on each trade.
As the Swiss Franc is not nearly as liquid as the Euro, on an intraday basis it is important to know that this negative correlation can breakdown to a degree. Finally, should the Swiss political and/or economic environment (in particular, monetary policy) begin to substantially deviate from that of the Euro zone, a breakdown of this negative correlation on the longer timeframes could be seen also.