Are you a forex trader who wants to know how to leverage the power of commodity currencies? If so, it’s imperative to learn how these unique kinds of FX assets work, why so many experienced and new traders use them, and what the best ones are. Luckily, the concept is much easier to master than most people think. That’s because commodity currencies are nothing more than a special kind of asset that you’ve probably already traded but didn’t realize it at the time.

There’s a lot of discussion in the financial media about the pros and cons of commodity currencies, which ones are the best for new investors, and whether they are good or bad for the markets. Additionally, once people begin exploring the topic, they usually decide to use one or more of the currencies in their daily transactions. The main thing to know is how to select a commodity currency that fits your style of trading, risk tolerance, and budget. The best place to begin is to get a handle on what commodity currencies are.

What Are Commodity Currencies?

These are a relatively well-known and widely traded asset class. They are the fiat currencies issued by nations, usually developing ones, that are closely tied to a given export. If Nation A mostly relies on its income from exporting iron ore, then it’s fiat-currency would fall into the commodity currency category. That’s because, to continue with the hypothetical example, when the price of iron ore rises on the world market, the fiat money issued by Nation A would also perform well in comparison to other offerings in the FX marketplace. Of course, the trading world is a highly complex place, so all those definitions should be taken with that in mind. Few assets’ prices go up or down in a linear fashion, particularly in the foreign exchange sector.

Why Traders Use Them

Even brand-new traders who have just learned their first lessons about what is forex trading can potentially gain an edge by leveraging the unique power of commodity currencies. Intermediate-level and experienced investors also prefer to add one or more commodity currencies to their daily activity. Why? Because it’s usually easier to forecast the price of a given FX pair when one or both of them are tied to the price of a nation’s most important export. For developing nations, the advantages are significant, especially during years when they do well in the export trade and find buyers for some or all of what they sell.

One factor that makes the Australian and Canadian dollars so popular with FX practitioners is that they’re both commodity currencies. The former typically rises and falls based on the international demand for iron ore, while Canada’s dollar is closely associated with its sales of oil. Keep in mind that it is developing nations that are most often tied to one or two export commodities, so Canada and Australia are not typical examples. More common members of the commodity currency club include Peru (copper) and Columbia (oil), whose sol and peso enjoy strength or weakness depending on the global demand for oil and copper on a particular day.

The Benefits

What are the benefits to traders who want to use these types of FX pairs? There are several, the most prominent being the fact that it’s simpler to make educated guesses about which direction prices will move. The Peruvian sol is often viewed as a stand-in for the price of copper. Some traders prefer to study the price of copper to determine how strong or weak the sol will be in the near future. In a similar way, it’s possible to track multiple other fiat currencies, like the New Zealand dollar or the Russian ruble, based on the international performance of agricultural stocks or oil, respectively.

Potential Pitfalls

While it might seem easier to focus on the performance of a single item, like copper or iron ore, the process can get tricky. That’s because many nations share a common product, oil being the best example, that their currencies are tied to. When oil does well, the analyst is faced with a basket of denominations that could all get stronger at the same time, which makes price prediction that much more challenging.

Which Ones Are Most Common?

It’s helpful to know which are the most commonly-traded commodity currencies in the marketplace. For instance, the latest listing includes the Norwegian krone, Chile’s peso, Russia’s ruble, South Africa’s rand, and New Zealand’s dollar. All are closely connected with each nation’s export business, for better or worse.