Reserve and Commodity Currencies in Forex

Currencies sort by what they are for, not by where they are from

The most useful division in currency trading is not geographic. It is functional, and it has two sides.

Reserve instruments — the Japanese yen, the Swiss franc, the US dollar, gold and government bonds. These meet rising demand when political crises and military tensions appear. Not because those economies are unaffected, but because they are where money goes when it stops looking for a return and starts looking for somewhere to sit.

Resource currencies — the Canadian, Australian and New Zealand dollars. These belong to economies whose exports are commodities, so they are bought when the world is producing and consuming, and sold when it is not.

The consequence is direct: on the same headline, the two groups move in opposite directions. A pair with one from each side — AUD/JPY is the classic — is not really a currency pair at all. It is a risk appetite instrument.

A shock on a timeline with the reserve group rising into it and the resource group falling away — One event, two directions. Which side of the line a currency sits on is a property of what it is used for, and it does not change with the news. Click to enlarge

What that does to a pair

Read a pair as two separate stories and the behaviour stops being surprising.

AUD/JPY, NZD/JPY — resource against reserve. These fall hardest on bad news and rise hardest on good, because both halves push the same way.
USD/JPY — reserve against reserve. Bad news pulls both, so the pair often does very little on the day of a shock and then resolves on the rate difference.
USD/CAD — reserve against resource. A crude oil collapse and a flight to the dollar are the same trade in this pair, which is why it moved so cleanly through 2020.
EUR/USD — the euro is neither, which is part of why it is the most rate-driven of the majors and the pair the later lessons use most often.

The commodity index, and reading a currency through it

If resource currencies are bought and sold with the commodity cycle, then the commodity index is a leading read on them rather than a separate market. The source makes this explicit with a chart of the global raw-materials index and then asks the reader to pick a pair to trade off a divergence in it.

The exercise is a good one and it is worth stating what makes it answerable. If the index is diverging downwards, the currencies that fall are the ones that sell what the index measures — and the currency to buy against them is a reserve instrument, because weakening commodity demand and rising risk aversion usually arrive together.

The same logic runs in reverse through the whole of lesson six: the dollar index and commodity prices are on opposite sides of most days, because commodities are priced in dollars.

The same lot size is not the same risk

Over one two-month stretch the source measures EUR/USD falling 500 pips and gold falling 3,400. Same period, same account, same lot size — and nearly seven times the money at stake.

This is the reason a bias is not a plan on its own. Deciding you are bearish tells you the direction; it tells you nothing about how much of your account a normal week will move. The instrument decides that, and the instrument specifications page has the daily-range figures the sizing has to come from.

Position size belongs to the instrument, not to the account. Carrying one size across instruments is the most common way a correct view still loses money.
A wider-ranging instrument is not riskier. It is riskier at the same size, which is a different statement and a fixable one.

A currency pair falling five hundred pips over a period in which gold falls three thousand four hundred, drawn to one scale — Both moves are real and both are ordinary. Only the second one empties an account sized for the first. Click to enlarge

Market bias: deciding the direction before you look for a trade

The source is blunt about this — without a bias toward the market, trading is essentially without an aim. The reasoning is not motivational. If you have not decided which way you are leaning, then every setup looks equally good in both directions and you will take the one the chart happens to offer, which is a description of drifting rather than of trading.

Three tools are given for forming it, and they are worth taking in order:

Living with one pair. Watching a single instrument long enough to know what is normal for it — and avoiding the constant switching that makes that impossible.
Fundamental analysis. Rates, growth, inflation, the curve — everything from lesson five onward. This is the input with the longest shelf life.
Long-term technical tools. Not for entries, which are a different job, but for confirming that the chart agrees with the story you have built.

Three inputs feeding one decision about direction, with the trade taken only in the direction the decision points — Bias first. The setup does not choose the direction — it chooses the moment, once the direction is already settled. Click to enlarge

What to take from this one

Three things:

Currencies split by function. Reserve instruments are bought when the world worsens; resource currencies are bought when it gets busier. A pair is two of those stories at once.
The commodity cycle is a leading read on resource currencies, and the dollar sits on the other side of it — which lesson six takes apart.
A bias sets the direction and the instrument sets the size. Getting the first right and the second wrong is still a losing month.

Next: reading the calendar properly

What the previous, forecast and actual columns actually mean, why the surprise moves the price rather than the number, and one release day read across three markets.

Back to the twelve lessons

Reserve currencies, resource currencies and market bias