Forex trading is when you buy and sell foreign currencies to try to profit from the change in value of one currency against another. Also known as foreign exchange and FX trading, forex is the world’s largest financial market. In this guide, we’ll explore how forex trading works, its benefits and risks, and how to choose a forex broker.
There are many practical reasons why people exchange currencies, like when you’re travelling internationally and you need to exchange your Canadian dollars for foreign currency, but a big percentage of global forex trading is done purely to make money.
The aim of forex trading is simple: to profit from the change in value of one currency against another. Let’s look at some key terms and concepts to explain how it works.
Forex is short for foreign exchange. It refers to the buying and selling of global currencies, and forex trading is when you sell one currency to buy another.
Currency values are constantly fluctuating relative to one another, driven by factors such as the strength of the economy, interest rates, inflation, and supply and demand. Forex traders aim to profit from these fluctuations, and with daily trading volume of US$7.5 trillion as of 2022, forex is the world’s largest financial market.
Forex is traded in currency pairs, such as CAD/USD, EUR/GBP and USD/JPY. Each currency has its own three-letter code to make it easy to identify.
Pairs show you how much of one currency it will cost you to purchase another — so if you type “CAD/USD” into Google, the first result might show you that 1 Canadian dollar = 0.70 US dollars.
In any pair, the currency listed first is known as the base currency, and the currency listed after the slash is the quote currency. The price listed for a currency pair shows you how much of the quote currency you would need to buy one unit of the base currency. So if the EUR/GBP price is listed as 0.84, you’ll need 0.84 GBP to buy 1 euro.
Disclaimer: General information only. All forms of investments (and in particular, trading CFDs, commodities and forex) carry significant risk, including the risk of losing more than the invested amounts, market volatility and liquidity risks. Past performance is no guarantee of future results. Such activities are not suitable for most investors.Forex traders base their trading decisions on which way they think the value of one currency will move relative to another. So if you think the Canadian dollar is set to rise in value compared to the US dollar, you would buy the CAD/USD pair. But if you think the Canadian dollar is set to weaken against the US dollar, you would sell the CAD/USD currency pair.
Graham is a veteran investor who buys and sells currency pairs. Anticipating that the Canadian dollar will increase in value against the euro, Graham secures a contract to purchase CAD$100,000 for €68,000 (reflecting the current EUR/CAD exchange rate of CAD$1 = €0.68). Because his forex trading platform has spreads of 0.5%, it costs Graham €340 to make this exchange.
Time shows that Graham’s prediction is correct. The Canadian dollar rises to €0.70, so Graham trades $100,000 CAD back for €70,000, which is €2,000 more than he originally had. Once again, Graham is charged a 0.5% spread, which amounts to $500 CAD (€350).
In total, Graham gains €2,000 but pays €690 in fees, leaving him with a profit of €1,310.
If you want to speculate on currency price movements, you’ll need to open an account with a forex broker. Forex brokers are the intermediaries that allow you to trade on the global foreign exchange market. Brokers execute buy and sell orders for their clients.
In its simplest form, forex trading involves using one currency to buy another, but it’s often a little more complex than that. Let’s take a look at a couple of popular forex trading methods in Canada.
Forex CFDs (contracts for difference) are a common forex trading product in Canada. CFD trading is a type of derivative trading that allows you to speculate on the price movement of an underlying asset, in this case a currency pair, without actually owning it. You can speculate whether the pair will increase or decrease in value, which means you can profit in rising and falling markets.
CFDs also allow you to trade on leverage, which means you only need a small initial investment to open a much larger trade. This opens up the potential for high returns, but there’s also the risk of heavy losses. CFDs are complex instruments and you could lose more than you invest, so make sure you fully understand the risks involved before trading them.
A foreign exchange option is a derivative that gives you the right to buy or sell a currency pair at a specific price up until a nominated expiry date. The right to buy a currency is known as a call option, while the right to sell a currency is known as a put option. You pay a fee (known as a premium) to the option seller.
If the market moves in the direction you anticipated, you can exercise your option. But if the market moves against you, there’s no obligation to exercise the option — you will simply lose the premium you paid to the seller. This makes options a useful hedging tool.
The main cost you need to be aware of when trading forex is the spread. The spread is the difference between the buy (ask) and sell (bid) prices for a currency pair, with the buy price always higher than the sell price. In other words, the spread is how forex brokers make a profit — they sell currency at a higher price than they buy it.
Think of the spread as the broker’s way of including their commission as part of your transaction. The size of the spread is expressed in pips. A pip, short for “percentage in point”, is the smallest amount the price of a currency pair can change. Most currency pairs are quoted to four decimal places, so a pip is usually equal to $0.0001.
Some brokers will also charge a commission on top of the spread. Other costs may also apply depending on the trading platform you choose. These may include currency conversion costs, withdrawal fees and account inactivity fees.
Here’s what you need to do to open a forex trading account.
During the week, global forex markets are open 24 hours a day. This allows for the time differences between the four major global forex trading centres of Sydney (Australia), Tokyo (Japan), London (UK), and New York (US). As a result, the market opens at 5pm Sunday (EST) and closes at 5pm Friday.
There are many different forex trading strategies traders use in an effort to make a profit. Here are some common strategies you might like to research, but there are several more complicated approaches to consider as your experience grows.
Day trading is based on the simple premise that you don’t hold forex positions overnight. In general, the longer you hold open a position, the greater the risk of suffering a loss. To minimize risk, traders can close all positions held before the end of the trading day.
Scalping involves making frequent, short-term trades to take advantage of small price movements. While the aim is only to make a small profit from each trade, these little wins can add up over time. However, it’s a strategy that requires a lot of time and ongoing effort.
Swing trading is a medium-term approach designed to take advantage of price swings. The aim is to take advantage of the swing highs (peaks) and swing lows (troughs) that occur over several days to a few weeks.
This strategy involves holding a currency pair for the long-term, potentially for months or even years in the hope that its value will rise. Position trading is based on fundamental analysis and requires you to ride out any short-term fluctuations.
The aim of this strategy is to identify the price range within which a currency pair typically trades. By researching the past fluctuations of a currency, you can use that information to predict future price movements. The previous upper limit of a price is called its resistance limit, and the previous lower limit is its support limit. Traders use these resistance limits and support limits to make an educated guess as to when a currency’s value might rise or fall.
A forex signal is an indicator that lets a trader know it is time to buy or sell a currency pair. Signals can be generated by traders performing fundamental or technical analysis of the market, or they can be generated automatically by complicated algorithms. A forex signal specifies a currency pair, whether you should buy or sell, and the price at which you should enter and exit your position.
If you’re an experienced trader, you may be able to develop your own forex signal system to identify trading opportunities.
Alternatively, there are many free and paid forex signal services available to subscribers. These services will communicate trading signals to you by SMS, email or phone notification, and in some cases directly through your trading platform. You can then execute the trade manually, or you can set up your trading account to automatically execute trades based on the forex signals you receive.
Yes, forex trading is legal in Canada. However, you’ll need to make sure you’re dealing with a reputable and regulated broker.
The Canadian Investment Regulatory Organization (CIRO) regulates forex trading in Canada, so make sure you choose a broker that is a CIRO member as well as a member of the Canadian Investor Protection Fund (CIPF). The Canadian Securities Administrators and provincial regulators also oversee FX trading regulation at the provincial level.
Yes, forex trading is taxed in Canada. You’ll need to declare your trading profits to the Canada Revenue Agency (CRA) on your annual tax return. However, how you’re taxed will depend on whether the CRA classifies your forex trading profits as investment or business income.
If your profits are classed as investment income from a non-business activity, you’ll pay capital gains tax at 50% of your marginal income tax rate. But if they’re classified as business income, they’ll need to pay income tax.
The CRA will look at factors such as how many trades you made, how long you held trades and how much money you made when deciding how you will be taxed. If you’re unsure which category your trading activities fall into, speak to a tax professional.
It’s easy to get started with forex trading in Canada, so compare a range of brokers before deciding on the right platform for you. But forex trading is complicated and has a high level of risk, so make sure you fully understand the risks involved before parting with any of your money.
A foreign exchange option offers flexibility and could insulate you from poor exchange rates.
Learn the basics about Forex – the foreign exchange market where international currencies are traded against each other for a profit or loss.