Forex Currency Trading | Easily Understanding the USD/CAD

Forex Currency Trading Basics for USD/CAD

This article is an introduction to forex currency trading for USD/CAD - the US dollar and Canadian dollar exchange. In order to establish a sufficient introduction, we need to start by talking about the forex market as a whole.
This first section will be devoted to talking about how the forex market works, how it's different from other trading markets and the advantages to the forex market. Then we'll move on to talking about forex currency trading for USD/CAD in particular.
Before we start, I should mention that forex currency trading is a very risky endeavor and should be taken on with extreme caution. You should get expert advice from a financial professional before you begin trading.

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Forex Currency Trading Basics

Forex Currency Trading USD/CAD

Forex Currency Trading Basics

Forex Currency Trading Basics

What is It?

To get a grasp on the forex currency trading basics, we must first look at the forex market as a whole. The forex market is the same as any other market, it's a place to buy and sell goods and services.
Think of it as those ancient markets where people came together to trade goods, haggle and bargain over prices, with buyers, sellers, and middlemen. Except the forex market is not a physical location. It's a virtual, electronic world where everything is done on computers on virtual platforms that are all connected to each other.
The forex market is what we call over-the-counter (OTC), which basically means that you trade directly over an electronic platform instead of an exchange like the NYSE or CBOT. There are many advantages to this that I'll go into later.
The forex market is the largest and fastest growing market in the world with a trading volume anywhere from $3.21 trillion PER DAY according to the Bank for International Settlements.
Compared with the New York Stock Exchange (NYSE) which turns over an average of $87 billion in daily trading volume according to the World Federation of Exchanges 2006, the forex market is about 36 times the size of the NYSE. The forex market is a very large market with benefits that I'll go into later.

Market Players - Who trades in forex markets?

The major players in this market that trade the currency pairs and effect the markets are currency traders in corporations, financial institutions, and for personal use.

#1 - Tourists and Other Personal Currency Exchanges

Most people have been to other countries where they had to exchange their home currencies to the local currency so they can travel and spend money. And most people have used or at least come across those kiosks at airports that will take your US dollar (USD) and exchange it for the local currency.
Although these kiosks and banks and other retail currency exchange places base their rate on the general forex market, they set it themselves with a mark up to take a cut of that exchange.

#2 - Companies Doing Foreign Trade

When a company that manufactures products in Japanese exports their products to the US, they do it by selling it to US companies. The Japanese product was manufactured using the Japanese currency - the yen, and it is being bought by the US.
One of several things happen. The US company buys the Japanese product in US dollars and then the Japanese company converts it into the yen to pay for making more product in their country, pay it's workers, pay it's taxes, etc.
Or, the US company first exchanges the USD into the yen and pays for it in yen. Or, the Japanese company will receive USD, keep it in USD for other international transactions.
The forex currency exchange rate significantly affects foreign trade. If, for example, the Japanese yen becomes stronger compared with the USD, Japanese products will become more expensive to buy for Americans.
Why? Because the USD won't buy as much Japanese yen as it used to. This of course will lead to a decrease in exports out of Japan. That is why China pegs it's currency, the yuan, and keeps it low compared to the USD.
As long as they keep their currency weaker than it's supposed to be, they will keep their exports into the US high and prices of their good low in USD. Most of these forex traders use other derivative financial instruments like currency futures to hedge against the risks of currency fluctuations, which will not be discussed in this article.
As you can imagine, there is an enormous amount of foreign trade that occurs on a daily basis, and a lot of ensuing currency trading must take place for this foreign trading to happen. However, the fact is, only 5% of daily forex market volume comes from companies doing foreign trade.
Granted 5% of $3.21 trillion is still $160 billion a day in currency trading volume, but it is still relatively low if you look at daily trading volume as a whole. If only 5% of currency trading is done because of foreign trade, then where does the other 95% of trading come from?

#3 - Speculators

If 5% of forex currency trader volume is for foreign trade purposes, the other 95% of the forex currency trading volume that is left comes from the activity of speculators, i.e. people and institutions trying to make a profit from currency trading. Currency trading is one way Goldman Sachs was able to emerge back into profitability after nearly imploding back in the fall.
Some speculators are merely average joes sitting in their home offices and trading on their own accounts.  Many of these start out trading on forex demo accounts to practice their trading skills.

Speculators as Forex Trader

Among the 95% of forex currency trades done by speculators, there are many that act as a forex trader in the forex market.

#1 - Central Banks

Central banks play a pivotal role in how the forex market behaves. The news media tends to focus on stock market reactions to central bank announcements and actions, but the forex market takes it's cues from central banks as well.
The central banks main concern is the monetary system of their country and tries to control the currencies inflation (value of money going down, i.e. it costs more to buy stuff) and deflation (duh, the value of the currency going up and things getting too cheap to buy).
Central banks play a balancing act trying to keep these two factors in check so that it doesn't become too volatile, while keeping their country's economy growing. They have tons of influence over their economies and the economy of the world, so the forex trader needs to pay close attention to what they're up to.
Central banks will sometimes buy and sell their currencies on the forex market themselves to stabilize the market. It's called central bank intervention.
Sometimes central banks will talk about intervening and sometimes it'll work to stabilize the market enough to make the difference the central bankers are looking for. But catch is that if the central banks do this too much, they run the risk of the forex market ignoring them in the long run.
The Central Bank of Canada is currently running this risk with the USD/CAD. The Central Bank of Canada is concerned that the USD/CAD (the CAD has become stronger) has declined so far that it might limit the growth of the Canadian economy, i.e. it'll be too expensive for other countries, especially the US, to buy Canadian products, especially commodities. (On a side note, Canadian commodities are crucial to the USD/CAD forex market, but that'll be discussed later).
In an effort to weaken the CAD so that exports will be cheaper and more competitive globally, the Central Bank of Canada and the Finance Ministry of Canada is talking about doing something to weaken the CAD.
The caveat is that the Central Bank of Canada didn't do anything when the USD/CAD was almost at par, i.e. it cost about 1 USD to buy 1 CAD last year. Additionally, according to Sean Hyman, the writer of the article linked above, the Central Bank of Canada hasn't done anything to intervene since 1998.

#2 - Commercial and Investment Banks

These are the big dogs of forex currency trading. They do a bulk of the speculating, and they usually do a darn good job at it. Goldman Sachs, JP Morgan, Morgan Stanley, Merrill Lynch and Deutsche Bank are some of the big investment banks that make billions every year on forex currency trading.
There are two primary ways commercial and investment banks make money from forex currency trading. They trade currencies on behalf of their clients as part of a forex account or comprehensive asset management portfolio that includes forex currency trading as a component of the portfolio of investments.
The other way these commercial and investment banks make money is by trading their own money. Commercial and investment banks have a unique advantage in this regard. In addition to the normal technical and fundamental analysis that every forex trader must make, they also get the unique perspective of seeing trades executed by central banks and large hedge funds.
Because of the extremely high trading volume and liquidity of the forex market, no one single bank or fund can significantly move the forex market using raw cash power like in other markets. However, if a number of the central banks and large hedge funds are buying or selling a particular currency, it could signal a trend in that currency that the commercial or investment bank could capitalize on.

#3 - Hedge Funds

Hedge funds have become an important factor in all aspects of the economy and financial markets. In addition to being a major play in forex markets, they have incredible sway in other financial markets like the stock market and commodities market that can also influence the movement of the forex market.
For example, the record breaking oil prices of recent history was most likely caused by aggressive hedge funds that were seeking to drive oil prices up to make a profit. Of course it wreaked havoc on us all by drastically hiking up gas prices, but it also affected the forex market because many of the major currency pairs are tied to the price of oil such as both the USD and CAD, in effect affecting the USD/CAD currency pair.

Overview of USD/CAD - Forex Currency Trading

Here's a general overview of how the USD/CAD behaves. In order to know how to interpret and analyze the news coming out from the US, Canada and the rest of the world economy, we need a grasp of how they all relate and interacts and how it is all connected in the forex market. To really make sense of anything, we need to do a quick historical sketch of this long term relationship between the USD/CAD.

Quick History of the Canadian Dollar - CAD

The CAD was one of the few major world currencies in the post-World War II Bretton Woods system where the value wasn't fixed to gold. It was allowed to float until 1962 in response to a steep decline in value to the USD, where the USD/CAD was fixed at $1.0195 or $.925 CAD/USD. In other words, it cost $1.0195 USD to buy $1 CAD and it cost $.925 CAD to buy $1 USD.
The CAD was once again allowed to float in 1970 due to high inflation, after which it appreciated past the USD. High inflation wasn't unique to Canada. Post World War II, countries around the world began aggressive expansionary measures to rebuild and stimulate their economies.
It's very similar to what's happening in today's world economy. The governments decided to pump money into the economy in an attempt to stimulate it with jobs and production. In doing so, they caused wide-spread inflation all around the world.
This leads us to the first important lesson in the USD/CAD market.

Forex Indicators - Commodity is King

The high investment in expanding and stimulating the world economy in post World War II led to an increase in demand of commodities such as oil. In other words, in order for world economies to produce, they need raw materials and energy such as oil, minerals, lumber, etc. It takes natural resources to build stuff to sell.
This global demand for commodities jacked up the price and countries that exported these commodities saw an increase valuation in their currencies.
Canada was and still is rich in these commodities and in post World War II, the price of Canadian commodities such as oil increased, causing the CAD to increase in value as well. Commodities markets and prices are important forex indicators for the USD/CAD.
Let me paint a picture for you. Let's say oil is selling at $100 per barrel. Suddenly, for whatever reason, there begins heavy investment into the economy to produce more stuff. In order to produce and ship more stuff, it requires more oil to get the energy to produce and ship the stuff.
Demand for the oil goes up sharply, and since generally the supply of commodities such as oil is steady, the price for oil goes up too. So now, it costs $120 per barrel of oil. So how does this increase the value of the CAD?
In order for China to buy oil from Canada, they have to convert their currency into CAD to buy the Canadian oil. Instead of buying $100 CAD, they are now buying $120 CAD. This decreased the supply of CAD, which also ends up raising the price of the CAD as well.
There are many other forex indicators that affect the USD/CAD market other than the price of oil, but because such a big part of the Canadian economy is in commodities, it has a significant impact on the USD/CAD market.
It's by no means the only one among the many forex indicators, but it's a major forex indicator that needs to be considered in the matrix of forex indicators that affect the USD/CAD.
By the way, if you are interested in trading the forex market, you should consider signing up for a forex demo account first with a broker. This will allow you to test what trading skills you think you have, help you hone them if they are any good, and also give you an opportunity to evaluate your broker.

Back to the USD/CAD History Lesson

After riding high on commodity prices for many years, the CAD began to decline in the 1990's due to the emergence of the high technology boom in the US. Though it was a high tech bubble that eventually burst, during the boom years there were tons of investment that was going into US tech firms.
This caused an influx of money into the US stock market, which caused the price of the USD to increase. In other words, in order to buy stock in high tech start up companies in Silicon Valley, investors had to take their foreign currency and exchange it for USD on the forex market in order to buy the shares on the New York Stock Exchange or the NASDAQ.
This cause increase in demand for the USD caused the price to go up in the forex market. As investors were buying USD with other foreign currencies on the forex market, those foreign currencies lost value, including the CAD. That brings up the next important lesson in understanding the relationship between the USD/CAD.

The US Economy

Whenever there is a boom in the US economy like we saw in the high technology bubble and the mortgage securities bubble, you'll likely see a decline in the USD/CAD pair. Why? Exactly for the reason mentioned above.
Well, the technology bubble burst and so did the mortgage securities business. No one seems to really see anything else like that coming. The US economy is not as dependent on commodity exports like Canada, manufacturing has gone overseas almost completely, and technology is also shifting to countries in Asia like China and India.
But, the US has always made it's way in the world through innovation and that has what has always made the difference for the US economy. Who knows what the US will cook up next.
Of course, if and when the US economy begins to pick up and out of recession, watch for the USD/CAD to rise like it always has in a booming US economy. So the important indicators for the strength of the US economy will also be the indicators that will tell you which direction the USD/CAD might go. We'll go into those indicators in another article since we're wanting to just give the overview right now.

The Global Economy - Specifically Emerging Markets

In talking about how the US economy affects the USD/CAD, we also need to mention that the rest of the world plays an integral role as well. Just because the US stock market is going up doesn't mean the USD/CAD will go up as well.
We saw this take place in recent history during financial crisis in the fall of 2008. Because the USD is probably the safest cash haven on the planet, when the world economy was spiraling down, everyone took their cash out of more riskier markets, i.e. the emerging markets, which also has greater potential rewards, and stuck it back in the USD. In this case, the US stock market was plummeting, but the USD/CAD and really the USD in general sky rocketed.
Sometimes when the USD looks unattractive for whatever reason, many people opt to trade it in for the CAD.  Forex currency trading in USD/CAD has a lot of complexities.