USD/CAD Forex Trading Strategy

USD/CAD Currency Pair Overview

This article will cover the following

  • Overview of the US economy
  • Overview of the Canadian economy
  • Properties of the USD/CAD cross
  • Average spread, volatility, correlation to other pairs
  • Trading strategies
  • and more

As you well know, the US dollar is the world’s major reserve currency, which stood on one side of 87% of all trades in the Forex market as of April 2013, according to a report by the Bank for International Settlements. The Canadian dollar, on the other hand, albeit not as popular, also has its rightful place among the top traded currencies. And more importantly, it is one of the few so-called commodity-based currencies. More on that a bit later.

According to the Bank for International Settlements, the Canadian dollar, also known as the loonie, is the seventh most popular currency as it stood on one side of 4.6% of all trades in the Forex market as of April 2013. Meanwhile, the USD/CAD pair was the fifth most popular pair, accounting for 3.7% of the market’s total turnover.

US economy

United-States-Flag-1-iconThe United States is the world’s largest economic power with a nominal Gross Domestic Product (GDP) at the amount of $16.8 trillion in 2013. It represents almost 25% of the global nominal GDP. It is also the world’s second-largest trading nation.

The US economy is primarily service-oriented, as almost 80% of the GDP is produced by sectors such as real estate, transportation, financial services, other business services and health care.

The country is the second-largest manufacturer in the world with an industrial production of $2.43 trillion during 2013, or larger than the output of Germany, France, India and Brazil combined. Major industries are petroleum, steel, automobile production, aerospace, construction and agricultural machinery, chemicals, electronics, telecommunications.

Moreover, as of 2013 the United States is the third-largest producer of oil (8 453 000 barrels per day, or 9.97% of the global total oil production) and the largest natural gas producer (66.5 billion cubic feet per day).

Taking into account the sheer size of the US economy and its pillars of strength, one can clearly understand the effect of economic data from those sectors on the US dollar, and in turn on the global Forex market. After all, the greenback stands on one side of 87% of all trades, according to the BIS.

Major economic indicators

– Non-farm Payrolls

– Consumer Price Index

– Producer Price Index

– Trade Balance

– ISM Non-manufacturing

– ISM Manufacturing

– Federal Reserve Minutes

– Consumer Confidence (Conference Board and Thomson Reuters/University of Michigan survey)

– Retail Sales

– Industrial Production

To learn more about the indicators listed above, please read our article “Profile of United States’ Dollar – Major Economic Reports

Canadian economy

Canada-Flag-iconCanada is the fourteenth biggest economy in the world, with a GDP (purchasing power parity) estimated $1.518 trillion in 2013. Canada closely resembles the United States with its market-oriented economic system, types of production and high standard of living with a GDP per capita of $43 100 in 2013, according to which it ranks 19th (compared to $52 800 in the US, which ranks it 14th).

Canada’s economy is typically known as a resource-based economy as its initial development relied heavily on the exploitation and exports of its natural resources. And although the modern Canadian economy is well diversified, with GDP by sector distribution being typical for a developed country, the Canadian dollar remains with a high positive correlation with the prices of the most exported Canadian raw materials, such as crude oil.

Nevertheless, more than two-thirds of Canada’s Gross Domestic Product comes from its service sector, which employs three quarters of the country’s labor force. Gross Domestic Product composition by sector of origin looked in 2013 as follows:

– agriculture – 1.7%
– industry – 28.4%
– services – 69.9%

Canada enjoys extensive trade with the US thanks to the 1989 Free Trade Agreement that removed the majority of trading tariffs between the three countries. Five years later, the 1994 North American Free Trade Agreement expanded the trade union by adding Mexico.

Canada is one of the few highly developed economies, which is a net exporter of energy, underscoring the importance of the global energy sector for the country’s economy and the loonie’s value. Moreover, Canada is the biggest importer of crude oil in the United States, which, apart from the overall trade flow, additionally underlines the importance of the US economy’s health for its neighbor to the North.

Major economic indicators

– Consumer Price Index

– Net Change in Employment

– Unemployment Rate

– Gross Domestic Product

– Ivey Purchasing Managers’ Index

– Trade Balance

– Retail Sales

To read more on the subject, please refer to our article “Profile of the Canadian Dollar – Characteristics

Currency properties

Average spread

spreadDepending on the Forex broker used, the spread can be fixed, floating, or both. For the purpose of this article, we have chosen the average spreads provided by 10 brokers, namely Saxo Bank, Dukascopy, Alpari UK, XM, Forex.com, FxPro, Markets.com, eToro, FXCM and Iron FX, and aggregated all the spread data provided to a single average spread, in the USD/CAD case – 2.2 pips.

Relative performance against other pairs

We conducted a series of calculations to gauge the performance of the EUR/USD pair relative to other crosses which include either the euro, or the US dollar over a certain period of time. For details about the calculation’s results, visit the appendix. Calculations are conducted on the basis of the EUR/USD cross, which registered a prominent high on May 8th 2014 at 1.3993. Thus from here on, we calculate the movement of each euro and USD cross with May 8th as a starting point and spanning to the December 31st close.

In the case of the USD/CAD pair, in Table 1 we see that cross rose by 7.37%, which ranks the Canadian dollar 7th in our list of performers against the greenback (Table 1.1).

Correlations to other pairs

arrows_correlationIn finance, correlation refers to the connection between two assets and how they move in relation to each other. As a key component of advanced portfolio management, correlation is crucial for achieving maximized risk-adjusted return. Ranging between -1 and +1, a correlation close to the upper limit means that the two currencies are moving in almost perfect consonance, allowing for almost no diversification, and vice versa. A correlation of 0, which in the world of finance practically does not exist, means that movement of the two assets is completely random.

Below you can see a table containing pairs with some of the strongest positive and negative correlations relative to USD/CAD. The statistics are derived from daily market data encompassing 300 periods, spanning back from January 8th, 2015.

Top 5 positive correlations
USD/SGD 0.95
USD/JPY 0.85
USD/TRY 0.84
USD/RUB 0.83
USD/DKK 0.78
Top 5 negative correlations
EUR/USD -0.76
AUD/CAD -0.78
NZD/USD -0.86
GBP/USD -0.92
AUD/USD -0.94

Volatility

Volatility in Forex refers to the fluctuations a currency exhibits during trading. In turn, these fluctuations directly impact the amount of risk a trader is subjected to, but also his return. A higher volatility means that the currency could potentially perform a sudden and drastic move in either direction over a short period of time.

In contrast, low volatility implies that the exchange rate does not have the potential for wide fluctuations and instead moves at a steady pace over a longer period of time. Lower volatility carries less risk for market participants but it is also much harder to profit from, especially by shorter-term traders such as scalpers and day traders.

For the purpose of our article, we have selected to display volatility calculated for 2014 on a daily basis. Check the table below.

Date High Low Intraday Vol. Daily Vol.
Dec 31, 2014 1.1628 1.1563 0.562% 0.302%
Dec 30, 2014 1.1651 1.1593 0.500% 0.422%
Jan 01, 2014 1.0677 1.0585 0.869% 0.575%
Jan 01, 2014 1.0647 1.0616 0.292% 0.349%
Average for the year 0.563% 0.591%

We have estimated the intraday and daily volatilities using two calculations for the time span of January 1st 2014 – December 31st 2014. The formulas look as follows:

– Intraday volatility (%) = [(Intraday High – Intraday Low) / Intraday Low]%

– Daily Volatility (%) = [(Current Daily High – Previous Daily Low) / Previous Daily Low]%]

Based on our calculations, we estimate that the USD/CAD pair achieved an average intraday volatility of ~0.56% for 2014, while daily volatility on average was 0.59%. Compared to other currency pairs (as you would see in case you check out the other articles in this guide), the USD/CAD pair was overall not so volatile, albeit exceeding the EUR/USD pair’s respective volatilities of ~0.51% and at ~0.47%. For a comparison, check our table of aggregated volatility data in appendix (Table 4).

Delving deeper, the pair showed daily volatility of about 60 pips in January 2014, followed by a peak to 65 pips in late-April and May and a drop to around 55 pips at the end of August. Year’s high was reached in December at almost 75 pips.

In weekday terms, the USD/CAD cross experiences highest volatility on Friday, at an average 80 pips, when some of the most important economic indicators are released. The second-most volatile day is Wednesday, at around 75 pips, followed by Tuesday at 70 pips.

As for hourly terms, the pair quite logically, and by far, reaches a peak volatility of 22-25 pips between 12:00 and 16:00 GMT – the US trading session, when almost all of the major US and Canadian economic indicators are released.

Carry trade

interest_rate_carry_trade_percentageCarry trades are one of the most popular trading strategies used in the Forex market. When performing a carry trade, a trader typically sells a currency with a relatively low interest rate, while buying a higher-yielding one. The aim is to profit from the difference in interest rates, which can be substantial, especially when taking into account leverage. To learn more about carry trades, please read our article “Using Carry Trades to Maximize Profit“.

Although the USD/CAD pair currently provides some profit from interest, it is generally not suitable to be used for carry trades. Benchmark interest rates in the US and Canada do not diverge enough and the Federal Reserve has moved to tighten money supply, having already wrapped up its Quantitative Easing program and being broadly expected to raise interest rates in 2015. The US dollar is on the rise against its major trading peers, including the Canadian dollar. Moreover, the outlook for lower oil prices in the years to come, given the currently unfolding global oversupply, is expected to lay further pressure on the loonie.

Using a basic carry trade calculator shows that going short on USD/CAD with a standard lot and holding the position over 30 days would earn us around $62 in interest, respectively $6.2 for a mini lot and $0.62 for a micro lot. For comparison, going long on NZD/USD with the same parameters would earn us $267.

Trading strategies

arrows_strategyDifferent strategies can be employed when trading the USD/CAD pair. The pair is most liquid during the US trading session, given that the US and Canada share the same time zones. Logically, the most intense trading will occur at the release of economic reports such as the US non-farm payrolls and unemployment rate, economic sentiment, manufacturing and non-manufacturing activity growth, durable goods orders, consumer inflation, retail sales etc, and respective key data from Canada.

Trading the major economic releases and other events without the help of technical analysis is basically done using three general strategies – using a proactive, a reactive or a mixed approach. Proactive trading suggests entering a position ahead of the release of the data and basing your decision on analysts’ forecasts, while the reactive approach implies entering the market after the data is published. Logically, a mixed approach combines the previous two. To learn more about these styles of fundamental trading, read our articles “Trading the News – Proactive Approach“, “Trading the News – Reactive Approach” and “Trading the News – Combining the Proactive and the Reactive Approaches“.

Technical strategy

A simple, and yet fairly effective trading strategy for USD/CAD based on technical analysis is to trade bounces from a trend line. It is universal and applicable to other trading instruments, so feel free to employ it for other currency crosses as well. You can see the strategy explained and visualized in our article “Trading Trend Line Bounces