Commodity forex trading is a surprising concept for many beginners. Commodities are not traded on the forex market, only currency is traded there. So why introduce them into a forex trading system?
The reason is that commodity prices can affect currency prices. Although we are not trading in the price of raw materials directly, in some cases the price of a currency pair may be more or less directly linked to the price of a specfic commodity.
This is because the economies of many countries are based around a particular import or export. Where a country is exporting manufactured goods, this is not relevant.
But where they are exporting or importing raw materials, also known as commodities, changes in the price of these items will have a big effect on the country’s economic situation.
These raw materials include oil, metals, precious stones, unprocessed agricultural products, etc. Clearly many of the countries that are dependent on one of these commodities, are small or developing countries whose currency would not form part of a major pair.
These currencies are not likely to be of interest to most forex traders.
However, there are three countries of importance in the forex market whose economy is closely tied up with commodities. These are Canada, the world’s second largest exporter of oil; Australia, a major gold producer; and New Zealand, with a bigger basket of commodity exports.
Any of these currencies would be suitable for commodity forex trading systems. The USD/CAD pair is perhaps the most common.
With Canada being an exporter of oil and the USA being a big importer, a rise or fall in the price of oil is likely to affect this pair directly. It would be crazy to be trading USD/CAD without taking any notice of oil prices.
In the same way, traders involved with the Australian dollar need to be aware of the possible impact of changes in the value of gold. NZD pairs, however, are more complex because of the varied range of goods that New Zealand exports. The general commodity price index is the one to watch here.
Of course, even where there is a strong economic link to a particular commodity, the effect on currency prices is not necessarily direct. Other factors also affect the forex market.
Small changes in commodity prices are often ignored by the market. The effect is more noticeable when there is a large rise or fall or, indeed, a prediction of a major shift in the price of the commodity.
Often, the currency price will not react immediately. This creates an ideal situation for a forex trader with an interest in the commodity market. By identifying a trend in the price of oil, for example, traders can often enter the USD/CAD market ahead of a reactive trend forming in the price of the currency pair. This is where commodity forex trading can give traders a very valuable edge.
