One of the biggest mistakes that forex traders make is that they tend to operate in a bit of a vacuum, writes Christopher Lewis in the DailyForex.com.
A lot of the time, this is predicated upon the allure of forex itself: When you start seeing commercials for various currency firms, strategies, and indicators, they all count how great the currency market is. So by extension, a lot of traders will simply focus on just forex, and forget the fact that there are multiple factors that can move a currency pair.
One of the most common ways to find a correlation between markets is to use metals, mainly gold, and oil to predict currency movements. It's relatively simple when you think about it, that if a producer of a particular commodity sells it to a foreign investor or corporation, they choose to be paid in their local currency. Because of this, you can use a little bit of common sense and observation to predict where a currency pair may end up over the long term.
Let's take oil as an example: One of the world’s largest oil-producing countries is Canada. Even more important, the Canadian supply the Americans with quite a bit of their oil and the Americans are the largest consumers of that commodity. Having said this, if you can imagine a large American consumer or distribution network buying Canadian oil, what must happen? It's relatively simple; the American corporation would have to exchange US dollars for Canadian dollars in order for the Canadian oil company to get paid. Obviously, this can have an effect on money flow, and send it out of the United States into Canada.
As demand rises for crude oil, as a general rule you will see the Canadian dollar gained strength. This is because more and more people were willing to bid up the price of oil in order to obtain it. By doing so, they have to use more and more Canadian dollars to purchase that oil. Also, there will be more customers on the whole, which of course means more transactions anyways.
There are other so-called “petro currencies” out there as well. However, the Canadian dollar is by far the most liquid currency to trade. Other currencies include the Russian ruble, Saudi Arabian real, and the Norwegian krone. However, for most traders the Canadian dollar does quite well.
When it comes to trading metals, namely gold, there is by far one leading candidate: the Australian dollar. This is because Australia is the world's most major and largest exporter of gold. The thought process is the same as the oil markets, as traders wish to purchase more gold; they will eventually have to do business with the Australians. Australian miners wish to get paid in Australian dollars, obviously, so as gold rises in value, you have the same exact situation as you do in Canada with oil, the local currency rises in value.
What should also be noticed is the fact that both of these commodities are priced in US dollars worldwide. This means that the value of the dollar naturally can go down because it takes more of them to buy one of these commodities as they get more and more valuable. This doesn't necessarily have to be the case, but in general this is true.
While not a 100% correlation, if you put up gold and an AUD/USD chart, you will see that over time the two tend to work together. The same can be said for the USD/CAD chart and oil markets. However, you must keep in mind that the USD/CAD pair moves inversely, as it falls when the Canadian dollar rises and vice versa.
The next time you are trading these currencies, notice how sometimes the commodity markets will move first. If one of them breaks out, quite often you will see the other one react shortly thereafter. This can be a valuable tool for the trader that has the ability to follow several markets at the same time.
By Christopher Lewis, Contributor, DailyForex.com