Oil-forex correlations: how to trade oil with forex

Oil price and FX

Trading the oil price with FX pairs is a common way of taking a position on the commodity when you’re unable to take a position on the oil market directly.

Correlations between commodities and forex pairs aren’t uncommon due to the reliance of some economies on exports. The relationship can be both positive or negative but it’s important to note that they aren’t permanent. The correlations are stronger at times, and completely break down at others. This is because oil prices aren’t the only factor at play. So, while we’ll discuss some of the most common oil FX pairs, you should still look at the context at the time you’re trading. Failure to understand whether the correlation is strong or weak can result in large losses.

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Crude FX pairs

USD/CAD

USD/CAD is probably the trade that comes to currency traders’ thoughts first when oil prices start moving. The pair has traditionally been negatively correlated to the price of oil, however, this relationship is pretty inconsistent.

The main cause of the negative correlation was that the USD is being sold in both trades. Oil is priced in terms of US Dollars, so for every barrel of oil bought, units of USD are sold. And whenever UDS/CAD is bought, traders are buying a CAD for a certain number of dollars. This means that USD/CAD will weaken when oil – and CAD – strengthens, and vice versa.

Canada is also a major exporter of oil, most of which was traditionally bought by the US. So as oil prices fluctuated, the amount of money flowing from the US to Canada would change and impact the demand for the currency too.

And while the US still buys a lot of oil from Canada, its reputation as a net-importer of oil is inaccurate. The success of its drilling and fracking industry has increased US shale production to such an extent the US is now the top oil producer in the world.

This means that the correlation between USD/CAD isn’t as reliable as it was because higher oil prices no longer contribute to a high trade deficit and can actually decrease it. In fact, many expect the relationship to change from a negative correlation to a positive correlation as the US becomes more of a petrocurrency.

As the correlation is constantly changing, it's important for FX traders to look at recent price trends and the wider politico-economic situation to understand what position to take.

Learn what moves oil prices

CAD/JPY

Canada is one of the largest oil exporters in the world, so the country’s economy is closely tied to the commodity. When oil prices are rising, it increases the value of Canada’s currency, as more capital flows into the country.

On the flip side, Japan is a major importer of oil, so the price of oil will significantly impact how much the country’s economy can grow and how much the country has to spend.

This means that CAD/JPY is positively correlated with the price of oil. As oil prices rise, CAD strengthens while JPY weakens. While the relationship isn’t a one for one move, the broader trend tends to be the same.

Other oil FX pairs to watch

While these are the main two oil FX pairs, there are plenty of other major exporters and importers of oil that are regarded as ‘correlated currencies’. The problem is that they tend to have lower liquidity, and that means you’ll likely find spreads are tighter too.

Examples include the Norwegian Krone and the Russian Ruble, as both Norway and Russia are historically large oil exporters. Pairs to watch would include USD/NOK, CAD/NOK, and USD/RUB.

How to trade oil in forex

To trade oil in forex, you need to go through a few quick steps:

Open a City Index account or log in to an existing account
Search for a currency pair in our platform
Decide whether to go long or short on the price
Enter your positions, attaching stops and limits as necessary
Monitor and close your trade

Not ready to trade live forex markets? Practise trading oil-linked currencies in a risk-free environment with a demo account.

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