The Economics Behind the Canadian Dollar in Forex Trading

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Contributor, Benzinga
July 14, 2023

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The Canadian dollar (CAD), also known as the Loonie among forex traders, ranks in the top eight most-traded currencies in the world. As a member of the U.S.-Mexico-Canada Agreement (USMCA) and a major oil producer and exporter, Canada and its currency hold a prominent place in both world trade and Forex trading, making it an attractive opportunity for traders looking to capitalize on the forex market.

If you’re a forex trader and would like to learn more about exchange rates that include the Canadian dollar, the Canadian dollar’s importance in the forex market and the economic drivers involved in its market valuation, keep reading for Benzinga’s take on these topics.  

What is the Canadian Dollar (CAD) and Why is it Important in Forex Trading?

The Canadian dollar is Canada’s national currency, and it holds a special place as one of the major currencies traded in the forex market. The currency has the International Organization for Standardization (ISO) 4217 code of CAD. This code reflects Canada’s country code of CA and the type of currency D, which denotes a dollar.  

According to the Bank of International Settlements (BIS)’s April 2022 survey, transactions including the Canadian dollar made up a total of 6.2 percent of daily average forex turnover, which was 1.2 percent higher than the 5 percent market share observed in 2019. 

Daily turnover for the entire forex market averaged $7.5 trillion per day in April of 2022, and it grew 14 percent (from $6.6 trillion) since the BIS’s April 2019 survey. Given the huge size of the forex market and its massive daily monetary turnover, a 6.2 percent market share means considerable liquidity and a deep market for the Canadian dollar, which is good news for most forex traders interested in trading pairs that include CAD. 

The vast majority of CAD forex trades involve the USD/CAD currency pair that has the U.S. dollar (USD) as the base currency and CAD as the counter currency. This pair is unusual in the forex market because it typically trades in the Interbank forex market for settlement in just one business day versus the usual two business day spot settlement period.

CAD trades fairly actively in some cross-currency pairs, typically as the counter currency. These cross pairs include EUR/CAD with the EU euro as the base currency, GBP/CAD with the U.K.’s pound sterling as the base currency, AUD/CAD with the Australian dollar as the base currency and CHF/CAD with the Swiss franc as the base currency.  

In contrast, CAD trades as the base currency versus the Japanese yen in the CAD/JPY currency pair. You can trade CAD against more exotic currencies from emerging market countries where it tends to serve as the base currency. Examples of such exotic pairs include CAD quoted against the Turkish lira (CAD/TRY) and the Thai bhat (CAD/THB). 

With the wide array of currency pairs that include the Canadian dollar, forex traders of all risk profiles and account sizes can find an adequate trading vehicle for potentially profitable trades in this currency. For traders who prefer the greatest liquidity, the USD/CAD currency pair will generally make the most sense to operate in, while a more risk-oriented or trend trader might want to take a position in CAD versus a minor or exotic counter currency. 

Canadians and other traders based in Canada might want to shop around for the best Forex trading broker. Forex trading is highly regulated in Canada with several competent brokers and trading platforms available to retail forex traders.  

If you are based in Canada, then forex trading has oversight from the Investment Industry Regulatory Organization of Canada (IIROC). In addition to the IIROC, each province has a regulatory agency as follows: 

Keep in mind that jurisdictions have different rules and requirements for trading forex in Canada. Leverage ratios are limited to 50:1 for Canadian residents. 

Forex brokers based in Canada must adhere to the IIROC’s “Know Your Client” (KYC) rule, which makes the broker verify a slew of personal data before opening an account, including their client’s investment objectives and experience. The KYC rule specifies that neither you nor your family members can be “politically exposed persons.” 

Analyzing the Historical Performance of CAD in the Forex Market

Because of Canada’s close proximity to the United States and the importance of the U.S. as a trading partner with Canada, the Canadian dollar has been pegged to the USD throughout much of its history, most recently from 1962 until 1970. 

Today, the currency’s forex market valuation floats freely and typically reflects the monetary policy of the Bank of Canada (BOC) that sets the level of benchmark interest rates in Canada. 

Canada is a natural resources exporter, so commodity price changes in the metals, crude oil and lumber markets can directly affect the Canadian economy and the relative value of its currency in the FX market.

CAD’s recent trading history has seen the currency trading near parity with the USD in June of 2013 at 1.0133 before rallying to a high of 1.4689 in January 2016. Since then, the USD/CAD pair has ranged between 1.2100 and 1.4600, with the exchange rate recently trading closer to the high end of that range around the 1.3600 level.

Because of Canada’s close relationship with the U.S. and its resource-based economy, the value of CAD can be directly affected by shifts in the value of the U.S. dollar. As a result, CAD tends to display lower volatility versus the U.S. dollar than other major currencies do as the chart below shows. This means USD/CAD will typically be less risky to trade than other major currencies versus the U.S. dollar. 

volatility-chart

The implied volatility of the relatively stable USD/CAD currency pair typically ranges between 4 and 7 percent. Against other currencies, such as the euro, the pound sterling and the Japanese yen, CAD implied volatility usually ranges between 10 to 12 percent, while CAD implied volatility can be as high as 15 percent against riskier currencies like the Mexican peso. The CAD implied volatility is influenced by factors such as rate hike decisions by the central bank and fluctuations in oil prices.

The importance of currency pair volatility to a forex trader whose profitability depends on risk-taking or prudent risk management cannot be overstated. While higher volatility increases trading risk, it also increases potential profits for traders who find themselves on the right side of the market. 

For inexperienced traders, trading a market with high volatility without a proven strategy and trading plan can mean getting whipsawed in the market. This situation can easily result in unprofitable trade outcomes and possibly a blown-out trading account. 

Key Drivers Of the Canadian Dollar

CAD’s relative valuation in the forex market versus other currencies is largely affected by several fundamental and economic drivers that influence the equilibrium exchange rate that arises from the supply and demand for the currency. You can find listed below the key elements that most affect CAD’s FX market valuation. 

Economic Factors

The Canadian economy ranks eighth largest in the world by nominal gross domestic product (GDP) according to the International Monetary Fund (IMF), and CAD acts as a barometer of the nation’s economic health in much the same way as a stock’s price reflects the health of its issuing company. 

Fundamental economic data releases such as Canada’s Trade Balance, Unemployment Rate, GDP and consumer and producer prices all play a key role in determining how well CAD performs against other currencies. 

In addition to the macroeconomic factors that influence the value of CAD, the BOC’s monetary policy and benchmark interest rate levels play a vital role. The BOC sets Canadian interest rates at several meetings conducted throughout the year. Changes in the BOC’s monetary policy and the direction of Canadian interest rates can strongly impact the value of CAD. 

If a nation’s interest rates are relatively high with low perceived risk, then that tends to make its currency more attractive to international bankers and interest rate traders, which in turn increases demand for the nation’s currency in the forex market. On the other hand, if a nation has relatively low interest rates with high risk, then it tends to reduce demand for that country’s currency, which typically puts pressure on its various exchange rates. 

Another key economic factor that has a direct influence on the Canadian dollar involves the prices of key commodities that the country exports. Canada is a leading producer and exporter of crude oil with the world’s third-largest proven oil reserves. It exports industrial and precious metals and lumber, which makes CAD especially sensitive to these commodity markets. As a result, CAD is known in the forex market as one of the three commodity currencies along with the Australian and New Zealand dollars. 

Political Factors

Canada is the only major nation in North America that uses the parliamentary system of government and is a member of the British Commonwealth of Nations. Since the end of World War II, Canada has promoted collaboration between government and private industry to create an extensive social welfare system that includes socialized medicine. 

Justin Trudeau of the Liberal Party first became Canadian Prime Minister in 2015, and his center-left party again won a majority in the 2021 elections. The Liberal Party currently has a majority of 160 parliamentary seats, followed by the Conservative Party with 119 seats, the Bloc Québécois with 32 seats and the New Democratic Party with 25 seats. In recent decades, the two-party plus Canadian political scene has typically been dominated by both the Liberal and Conservative Parties.

Prime Minister Trudeau and his Liberal Party currently hold the most power in parliament, but their agenda of green energy and targets for greenhouse gas emissions could negatively affect the oil and gas sector of the Canadian economy. A decline in this key sector could ultimately negatively affect the value of the Canadian dollar in the forex market.  

Significant changes to the parliamentary membership or the election of a new Prime Minister from the Conservative Party could have a substantial impact on the value of CAD quoted against other major currencies. 

How Can Traders Use the Canadian Dollar in Their Trading Strategies?

Depending on your risk preferences, incorporating currency pairs that include CAD could be profitable with a viable trading strategy incorporated into a well-designed trading plan. If you tend to be a conservative trader and do well or prefer to trade in less risky markets, then the USD/CAD currency pair might be a good fit for you because of its relatively low volatility. 

For more risk-oriented traders with experience trading cross-currency pairs, you might find possible trade setups in the EUR/CAD, GBP/CAD, AUD/CAD or CHF/CAD pairs. News traders comfortable with possible volatility could trade around Canadian economic releases or the results of BOC monetary policy meetings.

Well-capitalized traders with more experience could find a number of potentially profitable bullish, bearish and neutral trading strategies combining CAD currency options with spot and currency futures positions. 

Retail forex traders with limited resources could use technical and fundamental analysis combined with prudent money management techniques incorporated into a sound trading plan to make money trading long and short CAD spot positions against the majors. 

Can You Make Money Trading CAD?

Without a doubt, you can make money trading CAD. As long as you can position yourself on the right side of the market, you can profitably trade CAD versus the USD or any of the minor and exotic forex pairs that include CAD. 

Nevertheless, to consistently make money trading CAD or trading any financial market for that matter, you will want to have developed a consistently profitable trading strategy that you incorporate into a trading plan along with prudent money management techniques. You will also require the necessary discipline to stick to your plan to improve your chances of success trading CAD. 

Frequently Asked Questions

Q

What makes the Canadian dollar go up?

A

Higher oil and other commodity prices, as well as interest rate hikes by the Bank of Canada, have been known to make the Canadian dollar go up relative to other national currencies.

Q

Why is the Canadian dollar so volatile?

A

The Canadian dollar is actually less volatile than most other major currencies versus the U.S. dollar. The intraday volatility seen in a currency pair that includes the Canadian dollar can usually be attributed to the release of economic data, either from Canada or from the issuing nation of the other currency in the pair. Other key elements that add to CAD volatility are shifts in the prices of oil, gold and lumber, which are three of Canada’s main export industries.

Q

Why is the Canadian dollar important?

A

One of the reasons the Canadian dollar’s value is important is because of Canada’s status as an exporter of oil, gas, lumber and mining products. Canada is a major buyer of U.S. export goods.