Even newcomers to the forex trading arena are familiar with the major and minor currency pairs; However, there are many other classifications that are used to indicate specific characteristics related to the available coupling. One of the most common terms is “commodity forex pair”. It is often used when describing the currency pairs of a country that exports a large amount of raw materials to trading partners around the world.
In these cases, the forex pair often correlates closely with observed pricing trends for the relevant commodity. For traders who follow fundamentals closely, opportunities exist when there is a supply or demand issue for a major commodity such as oil and gas, metals, precious metals, or even agricultural products.
In this article, you will learn about commodity Forex pairs, develop an understanding of what drives their pricing behavior, what pairs are the most popular today, and finally, how to take advantage of specific trends related to commodity Forex pairs.
What are commodity forex pairs?
To assert yourself in Forex pairs trading, a trader must have an edge. When spreads and leverage are taken into the equation, the odds in your favor are less than 50% on average. How can experienced traders develop this advantage? Strategies using technical indicators, complemented by a solid knowledge of fundamentals, have proven to be a powerful formula over time. One such approach is to follow the fundamental correlations between the commodity currency and the demand for raw materials in the country in question.
Many commodity currencies can be highly linked to a country’s import/export trade when it relies on natural resources, either from deep within the earth or growing on it. The main currencies that come to mind are the Canadian Dollar (CAD), Australian Dollar (AUD), and New Zealand Dollar (NZD). There are many secondary and exotic commodity pairs, but the spreads are often large, and liquidity is low – which is not a good recipe for profitable forex trading. Please be aware that trading is risky and can result in significant losses.
Commodity currency pairs that come to mind here are the Mexican Peso, Russian Ruble, Brazilian Real, Norwegian Krone, Venezuelan Bolivar, and Saudi Riyal when quoted against the US Dollar (USD). The pairing does not have to be USD, but liquidity issues and spreads often dictate that part of the pair be USD. In some ways, the Japanese yen is treated like a commodity currency as the country must import almost all of its oil and gas. Traders often look at the pairing of the Canadian Dollar with the Japanese Yen as both will naturally move in the opposite manner, making the impact of market oil prices on this pairing more evident.
These currencies may be sensitive to how the commodities associated with them are priced in global markets. The trader must also remember that currency values depend on more than just one variable. Commodity currencies are known to diverge and quickly lose correlation with commodity prices, and the nature of the commodity and currency markets. The trader must constantly monitor both indicators to ensure a suitable entry and exit point.
Commodity prices can fluctuate for many reasons. Economic fundamentals can have a major impact, whether it is fundamental changes in the global economy, interest rates, political conflicts or elections, war or insurgency, natural disasters, pandemics, crises, and even weather. Seasonality also plays a role in prices, especially for agricultural products, if the harvest fails, occurs infrequently, or is delayed. The uncertainty in this area is why options markets were created to help producers and users find stability in future price points.
However, accepting these uncertainties becomes an integral part of any forex trading strategy related to gaining an advantage. Trends can develop quickly, and can reverse just as quickly, but timing is everything. The recent conflict in Europe is a good example of this. It became clear that oil supplies on a global scale would be limited. Oil prices rose significantly, and the Canadian dollar suddenly gained new strength. Oil prices fell by 30% last month, but the Canadian dollar stabilized against the Japanese yen.
(See chart below)
What are the most popular forex pairs?
We have already mentioned the most popular forex pairs – the Canadian dollar, the Australian dollar, and the New Zealand dollar, each of which corresponds to the US dollar. Tight spreads and abundant liquidity on the global stage make strategies in these three pairs possible and profitable. Please be aware that trading is risky and can result in significant losses. However, to trade in these waters, the trader needs to understand the countries involved and the nature of the commodity market or markets in question.
The current geopolitical situation in Europe has underscored how volatile and erratic the oil industry is, but the same applies to other commodities. Being a major producer in the global market is one thing, but one must also understand the demand dynamics emanating from the destination country or countries for these exports. Let’s take a moment to clarify the issues surrounding these three major commodity currencies:
- Canadian Dollar or Canadian Dollar (CAD): If you want to trade pure oil and gas, the Canadian Dollar is your best bet. Canada consistently ranks fifth among the world’s largest oil exporters, and 75% of exports are destined for the United States. It is no wonder that the Canadian dollar is strongly linked to the behavior of oil prices.
- Australian or Australian Dollar (AUD): The Australian economy is closely linked to the export of minerals, precious metals, and anything else extracted from its soil. China’s industrial complex is fueled by the influx of raw materials from the country, as do other regional economies. Australian iron ore, coal and gas are major exports, and China buys a third of production.
- New Zealand Dollar or Kiwi (NZD): New Zealand is the world’s largest exporter of milk and dairy products, but also leads in meat and wool. While Australia feeds Asia’s machinery, New Zealand feeds its population. For betting on the agricultural sector, the kiwi tops the list of commodity-linked currencies.
No discussion of Forex pairs would be complete without mentioning Japan. Japan remains an economic power, but it must import almost every drop of its oil. For this reason, the yen (JPY) can be sensitive to energy price fluctuations and makes an attractive pairing with another commodity currency.
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How to trade forex pairs
Since the oil industry is of great importance, Forex commodity pairs based on crude oil deposits constitute a suitable example for demonstration purposes. Beginners like to think that importing countries are somehow able to control oil prices; However, the oil market is beating many drums – OPEC, reserve inventory data, political tensions in the Middle East or war, the status of China’s industrial complex, and even investor sentiment, driven by speculators trying to manipulate the market.
Within this background, let’s choose the Canadian dollar, but let’s also peg it to the Japanese yen to observe if there is a multiplier effect. Below is a daily chart of the CAD/JPY currency pair, provided by eToro:
Here’s the corresponding chart for the Oil ETF, also provided by eToro:
Russia invaded Ukraine in February 2022, but the impact on oil prices declined until late March and early April. Fundamentals suggest continuing to buy CAD/JPY at this point, as early interest in the pair has surged at that time. Oil prices then produced a strong two-month upward trend, peaking on June 7y. The same applies to the currency pair “CAD/JPY”. The CCI was already indicating an overbought condition – time to sell.
It is important to note that oil prices have fallen by 30%, but the CAD/JPY pair entered range mode only after a slight decline. Clearly the relationship broke down. This strategy requires you to monitor any cracks in correlation behavior to determine when to exit. Use a charting system that allows comparisons of rates of change to make this determination.
conclusion
Every Forex trader is always looking for an edge in the market, and one of the promising areas is trading Commodity currency pairs. The Canadian dollar, Australian dollar, and New Zealand dollar currencies, which are paired with the US dollar, are excellent places to start. Choose one and focus on the fundamentals of both countries, as well as the commodity in question. Develop a strategy and practice it on a demo system.
Major moves in commodity markets tend to be sudden and sometimes prolonged, which lends itself to swing or swing trading strategies, but remember that correlations can break down in the blink of an eye. Monitor the markets for suitable entry points and have an exit strategy already in place for later. Trading commodity forex pairs can be exciting, but you must be disciplined and rely on a step-by-step trading plan to succeed.
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