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Using petrocurrencies to make oil plays

Discussion in 'Forex Discussions' started by painofhell, Jul 8, 2015.

  1. painofhell

    painofhell Content Contributor

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    In order to succeed in the forex markets, traders need to take a holistic view of all the factors that can influence currency prices, such as movements in the stock market and the commodities market. These markets have an impact on all the other markets, and as such no trader can afford to be completely ignorant of the big trends within them, and how the asset markets interact with each other.

    As a result, forex traders often find themselves coming up with trade ideas for other markets, but are unable to put them into practice because most forex brokers don’t offer multi-asset trading, and it is hardly worth signing up for a second broker just to make occasional trades in other markets.

    However, there are ways in which you can profit from the moves of other markets directly through forex. One example of this is using the Canadian dollar to make oil plays. So, if you think the oil price is likely to go up, you could go long on CADUSD, and if you think it is going to go down, you could short it.

    Although most people think of Middle Eastern countries when the term ‘oil producing nation’ is used, there are many other countries that are highly prolific in this area, and one of them is Canada. As one of the top oil producing nations in the world, Canada’s economy is heavily tied in with the energy industry.

    In practice, this means that when the oil price rises, the Canadian economy is boosted, and demand for Canadian dollars goes up – sending the exchange rate upwards. When it falls, the Canadian dollar falls, and for this reason the Canadian dollar is thought of as being a ‘petrocurrency’ – i.e. a currency whose value has a very high correlation with the oil price.

    Also, while Canada has smaller oil reserves than some of the major oil producing countries like Saudi Arabia, it is the biggest exporter of oil to the United States, due to its proximity and the stability of its trade relationship with the US.

    Because the CAD and oil have a very strong positive correlation, forex traders who want to profit from changes in the oil price can bet on CAD. In fact, betting on CAD is a fair bit safer than making a straight commodities play on oil, as the oil price tends to be a lot more volatile than the CADUSD exchange rate.

    Another reason to use CADUSD to bet on oil is that the US dollar and the oil price have a negative correlation. Because oil is priced in US dollars, when one goes up the other tends to go down, and this can happen for a number of reasons. The most simple explanation for rising oil prices is that of an increase in demand or a decrease in supply.

    On the whole, the supply of oil is on a permanent downtrend, although new oil field discoveries or innovations such as shale oil extraction can see supply increase for a time. Also, supply disruptions such as wars in the Middle East can make prices increase dramatically.

    The factors that cause an increase in demand are more complex. Increases in population sizes are a big driver, as are economic and industrial booms.

    The price of the dollar can also impact the price of oil directly, as it is denominated in US dollars. For example, if the US dollar drops as a result of money printing by the Federal reserve, an expectation of high inflation, or a deteriorating current account balance, then the oil price can rise.

    When all these factors come into play – decreased supply, increased demand, and a depreciating US dollar – you can expect to see the oil price go up, and as we have established, the best way to profit from this is to go long on CADUSD.
     
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