13: Forex trading strategies: Commodity correlation (Oil)

Forex trading strategies: Commodity correlation (Oil)

Why are with this Forex trading strategies?

Oil is one of the world’s basic necessities. Among other things, it is needed to run factories, plants, machinery, ships, and cars. A decline in oil prices is a nightmare for oil producers but a dream come true for oil consumers.

The reverse is also true when oil prices hit record highs. In July 2008, oil peaked at over USD147 a barrel. Those were the days when oil producers were smiling and oil consumers were sweating.

Canada is a country that exports most of its oil. In fact, as one of the world’s top ten oil-producing nations, its economy is severely hit when oil prices decline. Many traders today also utilize the price of oil to predict the movement of the Canadian dollar.

When  oil prices  are high,  the Canadian  dollar  tends  to  strengthen.
When oil prices are low, the Canadian dollar tends to weaken. Japan, in contrast, is considered a net oil importer. This causes the Japanese yen to weaken considerably when oil prices are high and vice versa.

Many  traders  ask  me  for  a  “magic”  strategy to  trade  oil.  However,  I don’t particularly  like  to  trade  it because oil prices  can be very volatile.

Loyalty Program

An easier  improvisation of  trading oil  directly would  be to  utilize knowledge of oil prices to trade the CAD/JPY currency pair. As Canada is a net oil exporter and Japan is a net oil importer, the price of oil becomes a leading indicator for the movement of the CAD/JPY currency pair.

Information for start with this forex trading strategy

Time Frame

The commodity  correlation method  works with  the daily  charts  (D1).

FOREX-APPS-PIPS-WIZARD-PRO

This means that each candle  on the  chart represents  1  day of  price movement.

 Indicators

We use the average true range (ATR) indicator to set the stop loss for this strategy.

Currency Pairs

This strategy is used with CAD/JPY only, with the movement of oil prices acting as a leading indicator.

Strategy Concept

The price movement on the oil chart is used as a  reference to trigger a trade on the CAD/JPY. Technical levels of support and resistance on the oil chart are used to spot long and short trades on CAD/JPY. If candles close above resistance on the oil chart, a long trade is triggered on the CAD/JPY the following day. Similarly, if candles close below support on the oil chart, a short trade is triggered on the CAD/JPY the following day.

The risk to reward ratio is set as 1:3. A bigger target is employed to allow the trade to run its course.

Long Trade Setup with this forex strategy

Here are the steps to execute the commodity correlation strategy for long:

  1. Identify the resistance of the oil chart on the daily time frame.
  2. Identify a candle that closes above the resistance. (See Figure 9.11.)
Forex trading strategies: COMMODITY CORRELATION (PART 1)
Forex trading strategies: COMMODITY CORRELATION (PART 1)

FIGURE 9.11    Identify a Candle that Closes Above Resistance

Forex trading strategies: COMMODITY CORRELATION (PART 1)
Forex trading strategies: COMMODITY CORRELATION (PART 1)

FIGURE 9.12    Set Stop Loss and Profit Target

  1. Enter long on CAD/JPY at the opening of the next day’s candle.

  2. Set the stop loss at twice the ATR of the previous candle, which is 154 pips (77 x 2).

  3. Set the profit target at a risk to reward ratio of 1:3. In this example, the profit target is 462 pips (154 x3). (See Figure 9.12.)

Forex trading strategies: COMMODITY CORRELATION (PART 1)
Forex trading strategies: COMMODITY CORRELATION (PART 1)

FIGURE 9.13 Trade Hits Profit Target

From the long example in Figure 9.13:

Entry  price  =  80.10

Stop  loss =  78.56

Profit  target  =  84.72

The risk for this trade is 154 pips, and the reward is 462 pips if the profit target is hit. The risk to reward ratio would be 1:3, which yields a tidy 9% return if we take a 3% risk.

Short Trade Setup with this forex strategy

Here are the steps to execute the commodity correlation strategy for short:

  1. Identify the support of the oil chart on the daily time frame.

  2. Identify a candle that closes below the support. (See Figure 9.14.)

  3. Enter short on CAD/JPY at the opening of the next day’s candle.

  4. Set the stop loss at twice the ATR  of the previous candle, which is 234 pips (117 × 2).

  5. Set the profit target at a risk to reward ratio of 1:3. In this example, the profit target is 702 pips (234 ×3). (See Figure 9.15.)

Forex trading strategies: COMMODITY CORRELATION (PART 1)
Forex trading strategies: COMMODITY CORRELATION (PART 1)

FIGURE 9.14    Identify a Candle that Closes Below Support

Forex trading strategies: COMMODITY CORRELATION (PART 1)
Forex trading strategies: COMMODITY CORRELATION (PART 1)

FIGURE 9.15    Set Stop Loss and Profit Target

From the short example in Figure 9.16:

Entry  price  =  80.34

Stop  loss =  82.68

Profit  target  =  73.32

Forex trading strategies: COMMODITY CORRELATION (PART 1)
Forex trading strategies: COMMODITY CORRELATION (PART 1)

FIGURE 9.16 Trade Hits Profit Target

The risk  for this trade is 154 pips, and the reward is 462 pips if the profit target is hit. The risk to reward ratio is 1:3, which yields a tidy 9% return if we take a 3% risk.

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