Oil Prices & Forex Trading

Learn forex Nitty Gritty. Discover Forex Magic Machine. Wall Street analysts watch oil prices like hawks. During the early part of 2008, oil prices skyrocketed from near $75 to almost $140 within a few short months. This was more than a 100% increase in oil prices in a few months. All over the world, countries started feeling huge pressures on their balance of payment accounts. Many hedge fund managers heavily speculated on the increase in oil price. Some made a windfall, other lost when the oil prices suddenly collapsed.

Most of the increase in the oil prices was due to speculation by the hedge funds. When the stock markets crashed in the middle of 2008, most of the hedge funds had to liquidate their investments in oil futures to cover their stock portfolio losses. The prices came down just as they had gone up. The prices are down now due to low consumer demand in a global recession. But it is being predicted by the analyst that with a recovery in the global economy, the oil prices will go up again.

As oil prices go up, consumers have to spend more on oil. The more they spend on oil, the less they spend on other products. The less they spend on other products, the less profit other companies make. Declining profits means declining stock prices.

The opposite case is also true. The less the oil prices become, the more Wall Street becomes exuberant about the profit potential of companies. This increased exuberance translates into increase in stock prices. Two large futures exchanges are used to determine the prices of crude oil. One is the New York Mercantile Exchange (NYME) and the other is the International Petroleum Exchange (IPE).

Historically, rising oil prices have been associated with falling stock markets. NYME is where most of the crude oil futures are traded. By monitoring the movement of the crude oil futures in NYME, you can develop a feel of the future economic situation of the United States. Since oil is heavily traded in US Dollar, this affects the US Dollar. The net effect is however a bit complicated.

Let’s take a look at it more closely. When oil prices increase, the demand for US Dollar also increases as most of the countries need US Dollar to pay for their oil imports. Increased demand for US Dollar means that it should appreciate.

But this is not the whole story. Increased oil prices also take its toll on the US economy. The question is which effect is more important for the forex markets.

The effect varies from one currency pair to another currency pair. If you are watching a currency that involves the USD and a currency representing a country that does well during the times of high oil prices like Canada that has huge oil reserves after Saudi Arabia, the effect would be drop in the value of USD/CAD pair. US imports more oil from Canada than any other country. If you are watching a currency pair that involves USD and a currency whose economy is hampered by the rising oil prices, the demand for USD will rise.

So some currencies have positive correlation with oil prices and other currencies have negative correlation with rising oil prices. The currency pair CAD/JPY shows the strongest reaction to rising oil prices. Japan imports almost 100% oil.

So when oil prices rise again, watch for a currency pair that has the strongest correlation with oil prices like CAD/JPY. CAD is positively correlated with oil prices and JPY is negatively correlated. So CAD/JPY can be a very good currency pair to trade during times of rising oil prices.

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