When investors trade currencies in the large liquid foreign exchange market, they’re engaging in forex trading. Forex, short for foreign exchange, offers opportunities to turn a profit in the world’s most traded 24/7 market, where traders exchange one currency for another at an agreed price. Given its complexities, forex trading is best suited to experienced investors, though many new traders quickly succumb to the excitement of this dynamic market.
How does forex trading work?
Forex traders come to the market with a single aim: profit from the sometimes minute changes in value of one currency against another. They do this by basing their investment decisions on whichever way they think forex prices will fluctuate in the future.
For example, if experts anticipate that the Canadian dollar will decrease in value against to the US dollar, forex traders will sell their Canadian dollars and buy US bucks. If the US dollar then increases in value, the trader gains greater purchasing power to buy more Canadian dollars than they initially had, resulting in a tidy profit.
On the global forex market, currencies are quoted in pairs, that is, in terms of their value against other currencies. In the forex market, these pairs are expressed as CAD/USD, GBP/EUR and USD/GBP. You’ll sometimes hear these pairs referred to by nickname. Keeping things lively, USD/CAD is often called the “Loonie,” AUD/USD the “Aussie,” EUR/GBP the “Chunnel,” GBP/USD the “cable” and USD/CHF the “Swissy,” among others.
You’ll find a range of trading platforms to choose from for forex. To place a trade, you simply select what you want to buy or sell and indicate the amount of your transaction.
What are the benefits of forex trading?
Forex trading has many advantages for the right investor, starting with its 24/7 accessibility. Unlike the New York Stock Exchange, which is open weekdays only from 9:30 a.m. to 4 p.m. EST, the global forex market runs Monday through Friday around the clock. This means that forex prices constantly fluctuate, offering plenty of investment opportunities for traders.
Investors use leverage to significantly increase their profits. Leverage allows investors to conduct a trade without putting up the full amount of that trade, controlling a large amount of money using a little of their own and borrowing the rest.
The forex market offers investors the highest achievable leverage among other markets, which means there is a much higher potential for profit from a small initial outlay. Unfortunately, this also means a greater risk for suffering a loss.
Example: Graham Trades EUR/CAD
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 €0.68). Because his forex trading platform charges a 1% margin on every trade, it costs Graham €680 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 1% trade fee, which amounts to $1,000 CAD (€700).
In total, Graham gains €2,000 but pays €1,380 in fees, leaving him with a clear profit of €620. In this case, his intuition and expertise has paid off.
* This is a fictional, but realistic, example.
What forex trading platforms are available?
Several forex trading services are available to Canadian investors, some geared toward beginners and others for experts.
Compare the fees and benefits of several providers before deciding on a platform that’s for you.
What’s the cost involved in forex trading?
As with any other form of investment, you need to carefully review the fees and charges that apply specifically to trading forex. To start, compare among a range of providers the margin you’re required to meet in order to make a trade. This margin of 0.5%, 1% or more will affect the total amount you’ll spend to buy or sell forex. For instance, if your account has a margin of 1%, a trade worth $100,000 will require you to spend $1,000.
In addition, most providers charge a commission for every trade you make. These fees can be as low as a few cents per thousand dollars, but some providers charge no commission on your trades. You may pay a fee to pay by credit or debit card.
Finally, consider the spread, the difference between the buy and sell prices for each currency pair. The spread is effectively what a broker or trading platform charges you to make a trade. Look for a trading platform that offers tight spreads to minimize your overall costs.
What do I need to open a forex trading account?
Most forex trading platforms allow potential traders to apply online for an account within minutes. The application process varies by provider, but you typically complete an online application and then wait to learn whether your application is approved.
To comply with the law, a provider may require you to supply:
Your full name and personal contact information
Your date of birth and Social Insurance Number (SIN)
Your employment status
Proof of government-issued ID, like a driver’s licence or passport
Financial details, including your income and network
Your trading experience or objectives
What are some common forex trading strategies?
With so many experts touting strategies for nearly any kind of investment, it’s no surprise that you’ll find several strategies for trading forex, from the basic tools to complex approaches.
One common strategy is to perform technical analysis or fundamental analysis to more solidly predict the future performance of a currency pair. Also common is a day-trading strategy, which 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.
A third strategy is researching the past fluctuations of a currency and using what you’ve learned 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.
Can foreign exchange make me rich?
While it’s possible to make money trading, it’s also inherently risky. Experienced trading, time and the ability to make upfront investments, and recover in the case of losses, are all necessary if you want to make meaningful gains.
Trading currency isn’t a get-rich-quick business. You’ll need to dedicate a fair amount of time to watching the markets, and if you’re inexperienced, you’ll also need to spend time immersed in learning the system. Strategies come in handy, but no single strategy is right for every situation.
What are some of the risks associated with forex trading?
Before you start trading forex, research and understand the risks involved with this sort of trading.
Even though you’ll put down only a small percentage of the value of your trade up front, you are ultimately responsible for the entire amount of your trade.
Forex rates are volatile and can quickly move against you, possibly resulting in a significant loss of money.
Markets are open 24 hours a day, which can result in devoting plenty of time to tracking open positions.
Predicting currency markets is difficult, and a wide range of factors affect currency pairs.
Even a stop-loss order, a hedging tool designed to minimize your losses, offers only limited protection against the risks involved.
Frequently asked questions about forex trading
Once you’ve familiarized yourself with the risks involved in trading forex, consider opening a demo account with a forex trading platform. Playing with trades will help you see if you have what it takes to successfully trade forex.
Short for “point in percentage,” a pip is generally the smallest movement an exchange rate can make. In most cases, a pip refers to the fourth decimal place of a currency, for example, the “5” in 1.445. In trading platforms with fractional pips, it can refer to the fifth decimal point, or the “6” in 14456.
In some currency pairs, a pip can refer to the second decimal place, the “4” in 89.84.
The most commonly traded currencies include the US dollar, the Great British pound, the euro, the Japanese yen, the Swiss franc, the Canadian dollar and the Australian dollar.
Due to international time differences, the forex market is open 24 hours a day from 5 p.m. EST on Sunday to 4 p.m. EST on Friday.
It depends. Read the fine print of any promotional carefully and compare its features and fees against other platforms.
Trading forex can be complex and features a lot of risk. Before getting started with trading forex, learn about all your investing options, research the risks involved and establish a maximum amount you are willing to experiment with.
An intraday position is a trade that’s opened and closed during the same trading day.
An overnight position is a forex trade that’s still open at the end of normal trading hours.
A stop-loss order is a hedging tool that allows your brokerage to buy or sell a currency at a price that you specify.
For example, if you currently hold the CAD/JPY currency pair and the price is CAD/JPY = 80 (meaning $1 buys 80 yen), you might put in a stop-loss order to sell at CAD/JPY = 78. This means that once the exchange rate hits 1 CAD = 78 JPY, your brokerage will automatically sell your holding.
No. Forex trading is conducted among a global network of banks, institutions and individuals around the world.
The value of currencies are affected by everything from supply and demand to economic conditions, political conditions, interest rates, inflation and consumer confidence.
Many first-time traders are unaware that forex trading places them at risk of losing more than their initial investment. However, it can be easy to lose your shirt if you’re not prepared for the full consequences of your trade.
Forex trading glossary
Ask price. The lowest price at which a trader can buy a currency.
At best. An instruction given to a broker to purchase or sell a currency at the best rate currently available in the market.
Base currency. This is the first currency listed in a currency pair. It shows the value of one currency when measured against another, for example CAD/USD.
Bear market. A market or period in which the prices are falling, which typically encourages investors to sell off a currency.
Bid price. The price a dealer is willing to buy a base currency at.
Bull market. A market or period in which the prices are rising, which typically encourages investors to buy securities or commodities.
Forex. An abbreviation of foreign exchange that refers to the market in which currency is traded.
Hedging. A strategy that protects an asset or liability from wild fluctuations in exchange rates.
Leverage. A trader’s ability to control a large amount of money in the forex markets by investing only a small percentage of the overall value of the trade.
Margin. Cash collateral deposited in case of losses due to foreign exchange trades, or the amount you’re required to spend to open a trade.
Margin call. A broker’s demand for additional funds to be deposited when your trading account doesn’t hold sufficient funds to maintain all your open positions.
Spread. The difference between a bid price and an ask price.
Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades. Read the Product Disclosure Statement (PDS) and Target Market Determination (TMD) for the product on the provider's website.
Rhys Subitch is a personal finance editor at Bankrate and former loans editor at Finder, specializing in consumer and business lending. Rhys has nearly a decade of experience researching, editing, and writing for startups, Fortune 500 companies, universities and websites. They hold a BA in sociology and a certificate of editing from the University of Washington.
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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 €0.68). Because his forex trading platform charges a 1% margin on every trade, it costs Graham €680 to make this exchange.