AUArticles (5)
What is forex?
<p>In the world of financial markets, forex has a special place. It is the world's most popular and biggest financial market, and as of April 2022, it has an average daily trading volume of USD 7.5 trillion. But what does forex mean, and how can you trade it? In this article, we’ll walk you through the basics of the forex market and the terms you need to know to start forex trading. </p> <h2>What is forex, and what is forex trading?</h2> <p>Forex, commonly referred to as FX, stands for the foreign exchange market. It’s a global marketplace where dozens of currencies are converted into one another for various purposes, such as international trade, tourism or personal gain. Due to its nature, forex trading involves a wide range of participants in this exchange process – governments, banks, multinational corporations, institutional investors, retail traders and even regular people. In fact, anyone who has ever travelled abroad and exchanged their home country’s currency for a local currency of their destination has done a transaction on a foreign exchange market.</p> <h2>Why is the forex market so popular?</h2> <p>There are many reasons why the currency market is so popular among online traders. Here are some of its main benefits:</p> <h3>Easier to follow</h3> <p>There are only a few currencies that most traders follow – these include the US dollar, Euro, and British pound. Other favoured but less frequently traded currencies are the Canadian, Australian, and New Zealand Dollars, and the Japanese Yen. As there are only a handful of popular currencies to focus on, it can help make it easier for traders to develop a deeper understanding of their behaviour and the factors that influence their movements. </p> <h3>Liquidity</h3> <p>The large number of participants and transactions bring high liquidity to forex trading, resulting in very low trading costs. And the ever-present supply and demand makes trading on leverage highly accessible. The latter allows good traders even with a small amount of capital to extract value from the forex markets, something that’s difficult to do when trading stocks.</p> <h3>Volatility</h3> <p>Forex prices can be influenced by various factors, which often cause high volatility and, as a result, numerous trading opportunities. Take a value stock as a comparison, it may hardly move some days, making it difficult to day trade. This is not the case with Forex trading, and you can find opportunities anytime during the day, whether it be after, before, or during work hours. </p> <h3>Round-the-clock access five days a week</h3> <p>Due to its decentralisation, forex transactions can be carried out at any time, except during the weekend. There is no centralised exchange, instead central banks, large banks, hedge funds, and retail brokers have built electronic networks, and deal directly with each other to facilitate trading outside traditional trading hours.</p> <h3>How does forex work?</h3> <p>When a forex trader exchanges a currency, you sell it and buy another one. Since there are always two currencies involved in this process, forex instruments are quoted in pairs – for example, EUR/USD or GBP/USD. The first currency is referred to as the base, and the second one is called the quote.</p> <br /> <br /> <img alt="base currency EUR - USD Quote currency" src="/getmedia/6ce661c1-e988-483e-ad7a-39908fb6f085/what-is-forex-trading-image01.png" style="display: flex; margin: 20px auto;" title="base currency EUR - USD Quote currency" /> <h2>Types of pairs in the forex market</h2> <p>Forex pairs are divided into three large groups depending on what currencies are included in them.</p> <h3>Major currency pairs</h3> <p>Major pairs include the currencies of the most developed countries traded against the USD. The US dollar is always present in these pairs as the base or quote currency because it is an official reserve currency worldwide, meaning it is widely used in international trade and held as a reserve by central banks across the world. It makes USD the dominant currency in forex and other markets like commodities that are also traded against it. Some of the most popular major pairs are EUR/USD, GBP/USD and USD/JPY.</p> <h3>Minor currency pairs</h3> <p>Minor pairs also include currencies of large economies but are not tied to the USD – EUR/GBP, EUR/CHF or GBP/CAD, for example.</p> <h3>Exotic currency pairs</h3> <p>Exotic pairs usually consist of one currency of a major economy traded against the currency of a developing country. Some examples are AUD/MXN, USD/HKD and GBP/ZAR.</p> <h2>How does currency trading work?</h2> <p>The value of a forex pair indicates the value of a base currency against the quote currency. In other words, it shows how many units of the quote currency you can get for 1 unit of the base currency. This is also called an exchange rate.<br /> For example, the EUR/USD currency pair exchange rate at the time of writing was 1.02839, which means for 1 euro, you would get 1.02839 US dollars.</p> <br /> <img alt="base currency EUR - USD Quote currency" src="/getmedia/b7de8307-5d14-4929-8cd6-d1aa06f5dc55/what-is-forex-trading-image02.png" style="display: flex; margin: 20px auto;" title="base currency EUR - USD Quote currency" /> <p paraeid="{b45da9f9-ab40-462f-8ec2-c07bc0d46b8a}{75}" paraid="900764359">It is important to note that since the forex market is decentralised, the exchange rate may vary from one broker or bank to another. </p> <p paraeid="{b45da9f9-ab40-462f-8ec2-c07bc0d46b8a}{91}" paraid="1272472748">When it comes to online trading, brokers source their exchange rates from a group of establishments called liquidity providers – usually banks and other large financial institutions and display them as bid and ask prices.</p> <h2>What are bid and ask prices in forex?</h2> <p>In forex trading, you have probably come across "bid" and "ask" prices. Think of the "bid" as the price you'll receive when you want to sell a currency. The "ask" is the price you'll pay when you want to buy. For example, if you're looking at EUR/USD, the "bid" tells you how many US dollars you'll receive for selling 1 Euro, while the "ask" represents how many US dollars you need to spend to buy 1 Euro. As you can see in the image below, you would receive 1.02839 USD for selling one Euro, while if you were to buy one Euro, you would need to pay 1.02847. This buy price is slightly higher than the sell price because of the spread, which is the difference between the “bid” and “ask” prices. </p> <br /> <img alt="table with instrument sell buy columns" src="/getmedia/0dc1949c-bd93-47ef-a868-7acf8d50ef8f/what-is-forex-trading-image03.png" style="display: flex; margin: 20px auto;" title="table with instrument sell buy columns" /> <h2>What is the spread in forex trading?</h2> <p paraeid="{b6259188-8ad3-442e-91ef-fc8790f06976}{19}" paraid="909016290">A spread in forex trades means the difference between the buy and sell prices that represents the transaction cost of every currency pair. Whether you buy or sell a currency, you will always be charged this amount upon opening a trade. The spread is what your broker earns for enabling you to trade. It is a markup, the same way as retailers adds a markup in any other product. However, the high competition in the forex markets ensures it’s the cheapest financial market to trade. </p> <p paraeid="{b6259188-8ad3-442e-91ef-fc8790f06976}{75}" paraid="1881540912">In the image below we see that the cost of trading is 0.8, for a 100,000 Euro transaction the cost would be 8 USD, making it unbeatably cheap. </p> <p paraeid="{b6259188-8ad3-442e-91ef-fc8790f06976}{95}" paraid="643707991">When you open a trade, the spread is deducted from the start. In a winning trade, the spread cost is deducted from a profit, and in a losing one, it is added to the loss. </p> <br /> <img alt="table with instrument sell buy columns" src="/getmedia/0d6ce7ac-c7be-40f0-82b6-4a292c3855ac/what-is-forex-trading-image04.png" style="display: flex; margin: 20px auto;" title="table with instrument sell buy columns" /> <p>It’s important to note that a spread directly depends on the liquidity of a currency pair. For example, the most liquid pairs (majors) usually have very tight spreads, meaning traders can open positions at a lower cost and make a profit faster if the market moves in their favour. Minor pairs are traded less often and have wider spreads, slightly increasing the trading cost, and exotic currency pairs have the widest spreads.</p> <p>The spread amount also varies from broker to broker and can even be different depending on the account type within the same broker. For example, if you trade forex with ThinkMarkets, a Standard account will give you access to tight spreads – just a few pips, but if you choose a ThinkZero trading account, most pairs will have 0 spreads.</p> <h2>What are pips in forex?</h2> <p>In forex trading, pip stands for percentage in point or price interest point. It is the smallest one-digit movement of a currency’s price measured by the fourth decimal point and used to calculate a spread.</p> <p>Here is a little graphic to help you understand how the price of a currency works:</p> <br /> <img alt="EUR/USD" src="/getmedia/5a1f9093-0c16-4fcd-b1c7-7e8274bec12c/what-is-forex-trading-image05.png" style="display: flex; margin: 20px auto;" title="EUR/USD" /> <p>Forex pairs that have Japanese yen as a quote currency are displayed only until the third decimal point, so the pip is measured by the second one.</p> <img alt="USD/JPY" src="/getmedia/5ee3c9cb-3972-4b49-b098-7c761624aefb/what-is-forex-trading-image06.png" style="display: flex; margin: 20px auto;" title="USD/JPY" /> <p>To calculate a spread, you need to subtract the sell price from the buy price. In our previous example, the spread is:</p> <br /> <img alt="1.02847 - 1.02839 = 0.8 pips" src="/getmedia/72f5e4d8-fc4b-4dbe-aa5f-b081b3ec9fbd/what-is-forex-trading-image07.png" style="display: flex; margin: 20px auto;" title="1.02847 - 1.02839 = 0.8 pips" /> <p>On ThinkMarkets’ proprietary platform, ThinkTrader, the spreads are displayed within each price quote for your convenience, so you don’t need to calculate them.</p> <p>Now, your next question may be how to calculate your profit or loss in pips when you trade forex and how to trade forex in the first place. Head over to our <a href="/en/trading-academy/forex/what-affects-forex-exchange-rates">next article</a>, where we discuss it in detail. You can also create a demo trading account on ThinkTrader to apply your newly obtained knowledge in practice.</p>
What are commodities, and how does the commodity market work?
<p paraeid="{77b08084-55df-414f-a05a-e7bbe41122e7}{62}" paraid="1480891234">The commodity market is the oldest existing financial market in recorded human history. Thousands of years ago, before paper money was invented as a unified medium of exchange, people used to barter commodities such as crops or cattle. At a later stage, many parts of the world used coins made of various metals as a form of payment. Even with the invention of modern currencies, reliance on commodities – gold in particular – remained in the form of the gold standard. This mechanism meant that a fixed price for gold was used to determine the value of a currency up until the 1970s. It was eventually abandoned to be able to adjust currencies to economic growth and have more flexibility to regulate other economic indicators, such as interest rates. However, gold, along with other commodities, remained an important part of the financial markets. <br /> </p> <p paraeid="{77b08084-55df-414f-a05a-e7bbe41122e7}{84}" paraid="563053549">The origins of commodity markets can be traced back to the need for agricultural producers to manage risk and secure a selling price for their goods ahead of the harvest. This led to the development of forward and futures contracts. One of the earliest examples of such a system was the Dojima Rice Exchange in Japan, established in the 17th century. <br /> <br /> In this article, we'll focus on the commodity market and explain what commodities are, what are the most popular commodities among traders and why commodity trading can be beneficial for your strategy. If you'd like to know more about the stock market instead, head to our <a href="/en/trading-academy/stocks/what-are-stocks">stocks</a> and <a href="/en/trading-academy/indices/what-is-a-stock-market-index">indices</a> articles.</p> <h2>What are commodities?</h2> <p>Commodities are raw materials that can be mined, grown or processed. These raw materials are usually divided into hard and soft commodities.<br /> <br /> Hard commodities include natural resources, such as precious metals (gold, silver, and others), and energy (oil and gas), used to manufacture finished goods or generate power.<br /> <br /> Soft commodities include agricultural products ready for producing food or materials in their final form – wheat, coffee, cattle., etc.</p> <br /> <img alt="" src="/getmedia/ed861ada-ea29-42e2-a541-428f1a0154e4/article-what-are-commodities-diagram.webp" style="width: 552px; height: 298px;" /> <p><br /> Hard commodities are usually more popular than soft commodities among traders due to their longer shelf life and lesser dependence on weather conditions.</p> <h2>Top 4 most popular commodities to trade</h2> <h3>Brent crude oil (BRENT)</h3> <p>Brent oil is one of the most traded commodities in the world. It is extracted from the North Sea in Northern Europe and is usually used to produce diesel and gasoline. Brent's price is slightly different than, US crude oil (WTI) due to export limitations on WTI and the different types and quality of oil. Brent is also considered more influential in the world due to its proximity to Europe, Africa and AsiaMiddle Eastern oil producers also use Brent as a benchmark when setting their prices. </p> <h3>US crude oil (WTI)</h3> <p>US crude oil, also called West Texas Intermediary, is extracted in the US, mostly in Texas. WTI has a lower sulphur content than Brent, making refining it easier and cheaper. However, geographical location makes international transportation of WTI more challenging. WTI is usually used for the same purpose as Brent. Hence despite the slight difference, their prices are usually very correlated.</p> <h3>Natural Gas (NGAS)</h3> <p>Natural gas is an important energy source used for heating, cooking and electricity generation. It is often found in the same areas as oil. However, unlike oil, gas produces fewer emissions when burning, which makes it a much cleaner and more versatile energy source that can be used as a fuel to power various machines, compared to oil-based products.</p> <h3>Gold (XAUUSD)</h3> <p>Gold doesn't need much introduction. For centuries, the yellow metal has been used in the form of money, as an investment instrument, and as a hedge against currencies' volatility. Gold is mined in multiple countries, with China, Russia and Australia topping the exporters' list. The main applications of gold nowadays are jewellery, electronic parts and money, as many governments keep gold reserves in their central banks as an indicator of financial health.</p> <h2>What is the commodity market?</h2> <p>The commodity market is a centralised financial market that gives producers and consumers of various commodities access to each other's services. Like the stock market, the commodity market consists of dozens of commodity exchanges worldwide, connected electronically.<br /> <br /> What sets a commodity exchange apart from a stock exchange is that the former transacts in commodities while the latter transacts in securities. </p> <h2>What are the benefits of trading on the commodity market?</h2> <p>The commodity market offers multiple benefits to traders, such as:</p> <h3>Diversification</h3> <p>Commodity instruments can be beneficial to any trading portfolio as they offer great diversification. Many commodities are often inversely correlated with other financial markets, which means they move in opposite directions, presenting multiple trading opportunities.</p> <h3>Hedge against inflation</h3> <p>Traders and investors have been using commodities, especially gold as a safe-haven asset and protection against depreciating currencies for years. In times of high inflation, it becomes more expensive to buy commodities, and their prices often start rising, attracting a lot of traders.</p> <h3>Steady demand</h3> <p>No matter the global economy's state, commodities are always in demand. People always need power and food. Even when oil and gas are replaced by clean and renewable energy and precious metals run out, people will always need agricultural products; hence there will always be a steady demand.</p>
How to trade commodities
<p>There are two types of traders in the commodity market. The first type mentioned in our <a href="/en/trading-academy/commodities/what-are-commodities">What are commodities, and how does the commodity market work</a> article is producers and manufacturers. These commodity traders are interested in the physical exchange of materials they produce or need for manufacturing. This category also includes investors who physically purchase precious metals like gold as a store of value.<br /> <br /> The second type is institutional traders that speculate on commodity prices purely for personal gain. Since online trading brokers like ThinkMarkets don't offer a physical exchange of assets, we'll focus on speculative trading in this article.</p> <h2>Commodity futures vs commodity CFDs</h2> <p>Commodities can be traded on the spot market, meaning you get physical product delivery. But this is impractical and costly as you need to safely store the item/s.<br /> <br /> If you’re just interested in speculating on the price change of a commodity, then an alternative to buying "spot" is to buy on the futures market. Suppose you were to purchase a futures contract with a three-month expiration date. If the contract's price rises at any point during this period, you’ll make a profit- you even have the option to sell it before it converts into a spot transaction upon expiry. Conversely, if the price declines, you can also opt to sell at a loss to prevent further potential losses before the contract matures.<br /> <br /> A commodity CFD is a contract between a retail broker and a client that follows the price movements of the underlying future.. The benefit of a commodity CFD is that it offers leverage, is cheaper to trade, and you can also trade in smaller sizes. The drawdown is that the CFD are not listed on an exchange, like futures are, which makes them less transparent.Yet, it is still the most popular way for retail traders to trade the markets. With CFDs, there is no expectation of receiving the physical commodity, and the futures contract is closed just before it turns into a spot deal.</p> <h2>How to trade commodities with CFDs</h2> <p>A CFD is one of the most popular derivatives in the trading world. Traders are usually attracted by an appealing offer CFD trading provides – speculation on the price movements of a commodity without buying it. If you are not familiar with the concept of CFD trading, we’ve covered it in detail in our <a href="/en/trading-academy/cfds/what-are-cfds">CFD trading: a beginner’s guide</a>.<br /> <br /> In a nutshell, CFDs track the real-time price movements of an underlying asset, whether it’s the current price of an instrument or its futures contract. Let's see how it works in a Brent oil trade example.<br /> <br /> In CFD trading, two types of trades (orders) are available, depending on the direction of the price movement: a long trade and a short trade.</p> <h3>Going long</h3> <p>Let's say the current price of BRENT is USD 85, and your research indicates that its price will go up. You place a long (buy) trade, and the price increases to USD 95. In this case, you profit from the price difference. If your prediction is incorrect and the price drops to USD 75 instead, you incur a loss. </p> <img src="/getmedia/6484b507-a8f7-4db8-9744-c01fbd553de3/article-how-to-trade-commodities-long.webp" /> <h3>Going short</h3> <p>If your research indicates that the price is going to drop, you open a trade in the opposite direction – going short (sell). If your prediction is correct and the price goes down to USD 75, the price difference is your profit. Should the market move in the opposite direction and reach USD 95, the price difference becomes your loss.</p> <img src="/getmedia/433f3338-d9c8-480d-9e97-1cd80cfc9eaa/article-how-to-trade-commodities-short.webp" /> <p>Now let’s see how you can calculate your profit or loss in these trade examples.</p> <h3>Lots</h3> <p>A lot represents a contract size in trading, which depends on the underlying asset this contract tracks. One standard lot has a set number of units of this asset. For example, in forex, it's units of currency, and in the stock market, it's the number of shares.<br /> <br /> The commodity market doesn't have a standardised measurement of units, as all commodities are different in shape and form. For natural gas, for example, one lot means 1,000 Btu (cubic feet). For gold – 100 ounces (about 2.83 kg). For BRENT and WTI – 100 barrels. In our trading example above, the contract size is 0.1 lot.<br /> <br /> You can find more details about every instrument on our <a href="/en/contract-specifications">Contract specifications </a>page.<br /> <br /> Now that you know about tick value and lots, let’s see how we can calculate profit in our first example, where we go long on BRENT. We have the following data:</p> <ul> <li>Entry spot: USD 85</li> <li>Exit: USD 95</li> <li>Tick value: 0.01 = USD 1 </li> </ul> <p>Here is the formula you can use:</p> <p style="font-size: 1.5em; font-weight: bold">Price difference/tick size × contract size = Profit/Loss in USD</p> <p style="font-size: 1.5em; font-weight: bold">(USD 95 - USD 85 = USD 10)/0.01 × 0.1 = USD 100</p> <p>Another important thing to understand is that CFD trading is leveraged, so when you open a trade at USD 85, you don't need to pay the full amount.</p> <h3>Leverage</h3> <p>Leverage is the process of using funds borrowed from a broker to open trades of a bigger size than your initial capital allows. To use these funds, traders are required to put down a small deposit, called a margin.<br /> <br /> With ThinkMarkets, you can trade Brent oil with a 100:1 leverage. It means that you only need to deposit 1/100th of the trade worth:</p> <img src="/getmedia/f6de5f4b-a76d-4610-8603-6c196cfd1d05/article-how-to-trade-commodities-leverage.webp" /> <p>It is crucial to understand that even though your capital is much smaller than the actual trade worth, leverage multiplies your profit and loss.<br /> <br /> When your capital is USD 8.5 instead of the full amount of USD 85, in a successful trade, your profit is multiplied and would still be USD 100 – bigger than your initial capital. However, if your trade is losing, the loss will also be bigger than your capital. That's why using risk management tools like stop loss and take profit when trading CFDs is crucial.<br /> <br /> This summarises the basic terms a trader needs to understand before getting started with commodity trading. In our next article, What affects commodity prices?, we'll explain the driving forces behind commodity prices to help you identify trading opportunities and understand whether you should choose a long or short trade.</p>
What affects commodity prices?
<p aria-level="2" paraeid="{e924138a-6dcb-453d-9c78-dc877d0b0cb4}{219}" paraid="578068771" role="heading">The price formation of any financial instrument on any market is subject to supply and demand. However, since commodities are natural resources and materials, the dependence of the commodity market on supply is much heavier than in any other market. In fact, the scarcity of these resources is exactly what makes them so valuable. Moreover, hard commodities like oil, gas or precious metals are not renewable, which only adds to their value. </p> <p paraeid="{e924138a-6dcb-453d-9c78-dc877d0b0cb4}{225}" paraid="1650331047">Following the law of supply and demand, a deficit in supply and steady demand usually leads to increasing prices and vice versa. Here are some of the major factors that affect price movements in the commodity market and can signal potential trading opportunities: </p> <p><br /> <br /> <img alt="" src="/getmedia/b291aca4-b0c4-4abb-b06e-fe873c2ec867/article-what-affects-commodities-prices-factors.webp" style="width: 552px; height: 297px;" /></p> <h3>Natural disasters</h3> <p>Since commodities are mined, extracted or grown, nature plays a significant role in these processes. A flood, drought or other severe weather conditions can disrupt the extraction. When it comes to soft commodities like wheat or corn, crops can simply be destroyed entirely. Moreover, unfavourable weather can also impact supply lines and make transportation and exports more difficult. Hence, whenever any of these events happen, it can reduce the supply drastically, and with the same level of demand in place, prices of affected commodities may start climbing. <br /> <br /> Keep in mind that nature also plays a role in seasonality. For example, agricultural commodities are seasonal, and their prices tend to decrease during harvest due to the influx of new crops. Natural disasters affecting commodity supply, like hurricanes, in many parts of the world can also be seasonal.<br /> <br /> Another seasonal trend to look out for is the US summer driving season. During warm months, people tend to travel more, increasing the demand for gasoline and driving the price of crude oil up.<br /> <br /> On the other hand, during cold months, traders usually see an increase in other energy products, such as natural gas, as it's widely used for heating.</p> <h3>Geopolitical tensions</h3> <p>Any prolonged political or geopolitical unrest, whether its localised strikes, territory dispute or war, affects supply channels. The Russian invasion of Ukraine is one great example to demonstrate how it works. Both countries are in the league of the largest commodity suppliers – oil and gas on the Russian side and wheat and corn on the Ukrainian. Sanctions applied to Russia and blocked by war supply chains in Ukraine caused a lot of volatility in the commodity market. </p> <h3>Currency exchange rates</h3> <p>Fluctuations in currency exchange rates are usually caused by inflation, interest rates and other economic indicators. As most commodities are traded against the US dollar, they are dependent on its value. Compared to other currencies, the USD's appreciation or depreciation can affect commodity prices, making buying the same materials cheaper or more expensive. </p> <h3>Economic growth or shocks</h3> <p paraeid="{5eba7bd5-70b9-4970-bfb4-bb9c5d629148}{105}" paraid="1068723066">Growing economies require a steady supply of commodities to produce various goods. Increasing demand with limited supply may lead to rising commodity prices. On the flip side, in times of crisis and crashing financial markets, people often turn to safe-haven assets like gold, driving their prices up. </p> <p paraeid="{5eba7bd5-70b9-4970-bfb4-bb9c5d629148}{115}" paraid="1345993558">However, as the infamous COVID-19 pandemic showed, economic turmoil means decreased production and demand for other commodities, like oil, which inevitably leads to lower prices. </p> <h2>How to trade commodities</h2> <p paraeid="{5eba7bd5-70b9-4970-bfb4-bb9c5d629148}{135}" paraid="365515749">With ThinkMarkets, there are two ways of doing it: commodity CFDs, stocks, and ETFs. <br /> </p> <p paraeid="{5eba7bd5-70b9-4970-bfb4-bb9c5d629148}{181}" paraid="137634938">Commodity stocks are shares of the companies that mine, produce or process commodities. Some examples of popular commodity companies are Newmont Mining (NEM), Devon Energy (DVN) and Wheaton Precious Metals (WPM). Their price movements are usually correlated with the price of commodities they deal with. <br /> </p> <p paraeid="{5eba7bd5-70b9-4970-bfb4-bb9c5d629148}{187}" paraid="1179293991">Commodity ETFs are exchange-traded funds that are invested in commodity futures contracts. Some of the most popular commodity ETFs are iShares GSCI Commodity Dynamic Roll Strategy ETF (COMT), Invesco DB Commodity Index Tracking Fund (DBC), and iShares Gold ETF (IAU). <br /> </p> <p paraeid="{5eba7bd5-70b9-4970-bfb4-bb9c5d629148}{209}" paraid="716910402">With ThinkMarkets, you can trade both commodity stocks and commodity ETFs, as well as CFDs. A commodity CFD tracks the price of the underlying commodity in a futures contract, giving you giving you direct exposure without the hassle. <br /> </p> <p paraeid="{7982c857-0853-4e82-9d1c-27b7f22c303c}{34}" paraid="343195021">If you are just starting out your trading journey, it is highly advisable to practice trading on a <a href="/en/demo-account">risk-free demo account</a> first.<br /> </p>
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How does the Commodity Channel Index (CCI) indicator work?
<p dir="ltr">The <strong>Commodity Channel Index (CCI)</strong> is used to determine the overbought or oversold conditions in the market.<br /> <br /> The CCI has been one of the most commonly used indicators for years in the commodity markets, and forex markets have warmed to it in recent years.<br /> <br /> Commodities markets have a long history of liquid trading conditions, meaning traders can look back at past data to back test and see how it has performed over the years.<br /> <br /> In fact, many traders around the world have used the CCI not only for commodities and forex, but for stocks and bonds as well.</p> <h2 dir="ltr">Structure</h2> <p dir="ltr">The CCI indicator is an oscillator, meaning it measures the strength or weakness behind the market, and whether or not a trend is reliable.<br /> <br /> The indicator has a centre line for the ‘zero level’ that shows a neutral reading. The indicator shows up in its own window below the price chart, and it is bound by 100 points on both sides of that zero line.<br /> <br /> The indicator line rising above the 100 level shows a potential overbought condition in a currency pair, while a move by the indicator line below the -100 level shows a potential oversold condition.<br /> <br /> Between those two levels, it shows that the market has either positive or negative momentum, but it doesn’t provide an actionable signal in and of itself.<br /> <br /> However, there are many ways to use the Commodity Channel Index, as we shall see.<br /> <br /> <img alt="" src="/TMXWebsite/media/TMXWebsite/commodity_channel_index_1.png" /></p> <h2 dir="ltr">Calculating the CCI</h2> <p dir="ltr">The Commodity Channel Index has been around for a few decades, becoming much more widely used as computing power became reasonably priced.<br /> <br /> Developed in 1980 by commodities trader Donald R Lambert, it is more complicated than most older indicators.<br /> <br /> This is because it was developed in an era when computers’ processing power was growing, meaning more mathematically complex equations were possible.<br /> <br /> The CCI helps figure out what the typical price (TP) of an asset may be at a given time.<br /> <br /> This is done by finding the mathematical mean of the high, the low, and the close prices and using this to determine the TP.<br /> <br /> Calculating a simple moving average for the price movement is the second step in determining the indicator’s reading. The final step to coming up with the CCI reading is this equation:<br /> <br /> <strong>CCI = (typical price – moving average) / (0.015 x mean deviation)</strong><br /> <br /> When the indicator was created, the 0.015 constant was used as a way of having between 70% and 80% of the readings fall between +100 and -100.<br /> <br /> The idea is that if readings rise above the 100 level, or if they fall below the -100 level, it shows that we are seeing an unusual deviation from normalcy.<br /> <br /> When we see these moves, the market is indicating overbought or oversold conditions - information you can use to underpin your strategy.</p> <h2 dir="ltr">Applying the CCI on MetaTrader 4 and 5</h2> <p dir="ltr">To apply the indicator on a chart in <a href="https://www.metaquotes.net/en">MetaTrader</a>, click on the ‘Insert’ tab, then the ‘Indicators’ tab, followed by the ‘Trend’ submenu, and finally on the Commodity Channel Index choice.<br /> <br /> You can then can choose the standard settings and attach the indicator, or customise the settings as you wish.<br /> <br /> One thing to bear in mind: choosing a too-short period (the default is 14) will make the indicator too sensitive to be useful.</p> <h2 dir="ltr">Reading the CCI on a MetaTrader platform</h2> <p dir="ltr">As mentioned previously, there are two areas that suggest an overbought or oversold condition.<br /> <br /> The idea is that when the market sends the signal line above the +100 level, the trader should start to look for signs of selling or rolling over by the market.<br /> <br /> On the other hand, if the signal line drops below the -100 level, then the market looks likely to be oversold, and the trader should be looking for the signs of a reversal.<br /> <br /> While the market is in an overbought or oversold condition, the trader will look for candlestick formations or perhaps another indicator to tell them when it is time to act.<br /> <br /> Take a look at the chart below.<br /> <br /> <img alt="" src="/TMXWebsite/media/TMXWebsite/commodity_channel_index_2.png" /><br /> <br /> You can see that the first set of red arrows was when the CCI spiked well above the +100 level.<br /> <br /> You can see that the market went on to drop from there as the New Zealand dollar fell from extreme highs.<br /> <br /> The next arrows suggest an oversold condition, and therefore - in theory - a buying opportunity. However, this signal failed.<br /> <br /> Conversely, the next two signals, the first one a sell signal and the second a buy signal, both worked out.<br /> <br /> The very last set (not marked by an arrow) is a sell signal that has yet to play out completely. In other words, out of the first four signals, three of them were profitable.<br /> <br /> However, no indicator is perfect, so traders use candlestick formations or perhaps moving averages to help confirm opportunities.<br /> </p>