From stocks and bonds to ETFs and cryptocurrency, there is no shortage of ways for Canadians to invest in 2021, and the advent of online and mobile trading technology has only made it easier. But did you know that one of the most popular forms of investing doesn’t require owning an asset like gold or company stock? Across the globe, trillions of dollars in foreign exchange transactions are executed daily through a phenomenon known as forex trading. But what is forex, and how does it work?
What Is Forex Trading?
The term forex comes from the words ‘foreign currency’ and ‘exchange’, and involves converting funds from one currency to another. In other words, whenever a foreign currency is exchanged, it can be considered a forex transaction.
Across the globe, trillions of dollars in forex transactions are executed daily. Once upon a time, the most common type of foreign exchange involved purchasing or selling goods across international borders or individuals exchanging currencies for travel.
However, in recent years, forex trading has become a popular form of investing, where the only goal is to buy and sell foreign currencies to make a profit. This is the activity we’ll focus on for this article.
What Is a Forex Market?
Forex is traded on foreign exchange markets, which exist as over-the-counter (OTC) electronic markets across the globe. Unlike stock markets, which are centralized across a small number of physical locations, forex markets are highly decentralized and almost always open for large banks and both institutional and retail investors. You can trade forex 24 hours/day.
Three Types of Forex Markets
Let’s take a look at the three different types of forex markets:
Spot Market
The spot forex market (on-the-spot) is the most common type of foreign exchange market. It involves a buyer and a seller negotiating a trade at a specified price. This price is determined by several underlying factors, including economic conditions, global events, and investor emotion. I’ll cover these in more detail later. When you exchange your Canadian dollars for USD through your primary bank, the transaction occurs on the spot market.
Forward Forex Market
In a forward forex market, contracts are made between two parties to buy a foreign currency for a specific price on a future date. The currency itself is not being traded; rather, it’s the right to buy the currency.
Futures Forex Market
Futures contracts are legally binding agreements to buy or sell a specific currency at a specific price and date in the future. With both forward and futures contracts, the currencies themselves are not usually traded – instead, large companies use them as a hedge against future foreign currency risk.
How Is Forex Trading Regulated In Canada?
Nationally, forex trading is regulated by the Investment Industry Regulatory Organization of Canada (IIROC), the same organization responsible for regulating investment dealers and trading activity on Canadian debt and equity markets. According to IIROC’s website, they set “high-quality regulatory and investment industry standards, protects investors and strengthens market integrity while maintaining efficient and competitive capital markets.”
Factors that Influence the Forex Market
The market determines the price of foreign currencies and, similar to the stock market, is influenced by several factors. Here are some of the underlying forces that help set the price of currencies:
Economic Performance
A country’s underlying economic performance can affect the price of its dollar. For example, if a country’s interest rates are high compared to other countries, it can attract foreign investment, promoting a strong currency. Having a low interest rate relative to competing economies can have the opposite effect.
Currently, interest rates in Canada are at all-time lows, which might lead one to believe that the value of our dollar would also be low. However, the Canadian dollar has risen substantially against the US dollar over the past year, partly because interest rates are also low south of the border.
A country’s credit rating is another factor that influences currency price. A strong or improving credit rating can help move currency prices higher, while a poor or slumping credit rating can drive them down.
Monetary Policy
A country’s central bank controls monetary policies. It involves, among other things, controlling the supply of money as a means of sustaining the growth of the economy at a reasonable rate. Limiting the money supply can cause the price of a currency to rise while printing more money can have the opposite effect. It’s all about supply and demand.
World Events
Similar to the stock market, forex markets, and the price of global currencies, are often influenced by major global events – natural disasters, wars and other international conflicts, a global pandemic – anything that might impact a country or region’s economic performance can affect the demand of its currency, thereby influencing the price.
Market Sentiment
Investor sentiment is fickle, and it is often tied to the aforementioned major world events. Fear and greed are powerful emotions. Anytime there is an excess of either one, it can cause foreign currency prices to fluctuate in either direction.
What Is a Currency Pair?
When forex is traded, the currencies being exchanged are listed in pairs, known as currency pairs. Currency pairs are made up of a base currency and quote currency. The base currency is always the first one listed in the currency pair, and the pair’s price represents how much of the quote currency is required to buy one dollar of the base currency.
For example, if you were exchanging Canadian dollars to USD at a currency pair price of $1.2230, the pair would be listed as follows: USD/CAD = $1.2230. In other words, it will take CAD 1.22 to purchase one US dollar.
How Currency Pairs Are Organized
For forex trading purposes, most forex brokers separate forex currency pairs into separate categories, as follows:
Major Forex Pairs
Across the globe, seven currencies make up the vast majority of all forex trades: US Dollar, British Pound Sterling, Euro, Japanese Yen, Swiss Franc, Australian Dollar, and our very own Canadian dollar. These currencies are included in the following major pairs:
- USD/CAD
- EUR/USD
- GBP/USD
- USD/CHF
- USD/JPY
- AUD/USD
Minor Forex Pairs
Minor currency pairs often include major currencies traded against each other, excluding the US dollar. A couple of examples would be EUR/GBP and EUR/JPY.
Regional Forex Pairs
Regional pairs include currencies that are often traded against each other, simply due to the proximity of the corresponding countries, i.e., Euro vs. Swedish Krona (EUR/SEK)
Exotic Pairs
When a major currency is traded against an emerging economy, it’s considered an exotic pair. An example would be the Euro vs. Mexican Peso (EUR/MXN)
Understanding the Spread When Trading Forex
The spread is the distance between the buy and sell price of a foreign currency. For example, the buy rate for USD will be slightly higher than the sell rate, and it’s how financial institutions make money on foreign exchange.
For example, let’s say you wish to buy USD 100 at a rate of $1.3200. This means that it will cost you 132.00 Canadian dollars to buy $100 US dollars. Immediately afterward, you decide to sell your USD back to Canadian. The sell rate might be closer to $1.2900, representing a spread of 3 cents on the dollar. If you proceed to sell, you’ll end up with only 129.00 Canadian dollars.
How to Trade Forex In Canada
So if this sounds interesting and you want to know how to become a forex trader in Canada, you can trade foreign currencies through any number of forex brokers. Forex brokers must be registered with IIROC, the aforementioned forex regulatory body in Canada. When you open an account with a broker, they are required to collect your personal information, including your age, occupation, SIN, and your net worth.
Most brokers offer multiple platforms tailored to different experience levels. The basic trading platforms feature low minimum account requirements, while advanced platforms will offer reduced pricing for higher volume, active traders.
Just like the leading discount brokers, forex brokers have mobile apps for convenient trading on the go and tools to help you with market research. The sky really is the limit. Customer support is available via email, telephone, or live chat.
List of Canadian Forex Brokers
Below is a list of four top Canadian forex brokers. Always make sure you do the proper research before getting started with forex trading or opening an account with any forex broker.
Interactive Brokers
Interactive Brokers (IBKR) is a leading online discount brokerage and forex broker based in the US and active in Canada. Interactive Brokers is popular with active stock traders who love their low fees, but they also stand out for their forex trading capabilities and excellent pricing on foreign exchange.
When it comes to forex, Interactive Brokers offers over 100 currency pairs across 23 currencies, sophisticated FX trading tools like real-time quotes, and up and down indicators.
For more information, check out our full Interactive Brokers Canada Review.
CMC Markets
CMC Markets allows leveraged trades through contracts for difference (CFDs). With CFDs, you are not trading forex but speculating on the future movement of global markets through a range of products, including forex, stocks, indices, and commodities. They boast spreads as low as .30 points on gold and .70 points on EUR/USD.
Forex.com
Forex.com gives you access to more than 200 global markets, including FX pairs, stocks, indices, commodities, and metals. You can open an account and start trading forex via desktop or mobile within minutes by sending funds to your account via a debit/credit card or wire transfer. They offer very low fees and spreads as low as 1 point. Anytime you’re dealing with leverage, your risk of losing money is amplified.
AvaTrade
AvaTrade is a globally licensed forex broker registered in Canada through Friedberg Direct, a Friedberg Mercantile Group Ltd. division, an IIROC, and a member of the Canadian Investor Protection Fund (CIPF). This means that AvaTrade customer accounts are protected in Canada by the CIPF up to a certain limit. They offer forex and CFD trading and have products and services to appeal to traders, from beginner to professional.
Leveraged Forex Trading
Leveraging occurs when you use borrowed funds to invest. For example, you contribute $5000, and your forex broker loans you an additional $20,000 by authorizing you to trade a maximum of $25,000.
The potential for gains is enhanced if the currency you’re betting against falls in value. On the downside, you will magnify your losses if the currency you traded against value increases. As you can see, your risk of losing is multiplied when you employ a leveraging strategy because you are investing money you don’t actually own.
Forex Trading – What to Know Before Getting Started
Forex trading can be a legitimate way to invest, but there is a great deal of speculation, making it very risky. As we learned in this article, several factors can influence the value of any global currency, so short-term fluctuations can be very hard to predict. In the short term, your risk of losing money on forex trading strategies is high.
Before you get started, make sure to do the proper research. As with other speculative investments, such as precious metals, penny stocks, or cryptocurrency, never invest money that you can’t afford to lose. Also, understand where forex fits in your overall investment strategy. You should never devote a large portion of your asset allocation to high-risk, speculative investments.
Once you’ve decided that you want to proceed, select an online broker with access to the currency markets. I’m not making a recommendation, but there are several low-cost, fully licensed foreign exchange brokers to choose from in Canada.
