From driving your car to heating your home, oil has become an integral part of daily life in our modern economy. Even though we are all slowly taking steps to reduce our dependency on oil, for the time being oil and gasoline are a big part of daily life in any developed nation on earth. And the currencies that you trade are sensitive to the price of oil.

Oil production is still very high, and oil prices are in a constant state of flux. It is important to understand this popular commodity, and this is a good example of intermarket analysis that you need to effectively predict exchange rates as a forex trader. With literally all major currencies from the US dollar to the Japanese Yen, changes in the price of oil can have a big impact on the value of that nation's currency.

In order to determine how much the price of a given currency is going to be affected by oil prices, the most important factor is to determine that currency's dependency on oil. Oil shocks or price increases act similar to a tax raise, stifling economic growth, whereas a decrease in the price of oil will do the opposite and encourage conomic growth (this is especially true for big oil importers).

You can directly use this knowledge in your forex trading: If there is a large decrease in the price of oil, this will probably mean that the currency of highly oil-dependent countries will appreciate. If there is an oil shock, it is more likely that these same currencies will depreciate. And you can also bet that if there is any big oil-related news, institutional forex traders will be jumping on it to buy or sell currencies accordingly.

In terms of the specific currencies that forex traders should focus on, the United States and Japan are the world's two biggest oil importers, and as such the dollar and the yen will be very sensitive to oil prices. Japan is a smaller island nation, and they lack the domestic energy requirements that their economy demands so they must import large amounts of crude oil. The United States, while they still import a large amount of oil, also has large amounts of natural resources such as untapped oil reserves. These two countries will be negatively affected by high oil prices.

The United Kingdom (and consequently the British pound) stands to benefit slightly from rising oil prices since Britain is a net oil exporter (though only by a small margin). The countries in the EU are mostly all oil importers, though not to the same degree that the United States and Japan are.

The specific currency pairs that will probably be most affected by changes in oil prices are the pound and Euro against both the yen and dollar, so: EUR/USD, EUR/JPY, GBP/USD, GBP/JPY. A spike in oil prices will likely cause all four of these currency pairs to go up, and a decline in oil prices will likely cause all of these currency pairs to go down.