James Douglas was born in Demerara (now part of Guyana) to John Douglas, a Scottish planter, and Martha Ann Tefler, a Creole originally from Barbados. Telfer was free coloured, which in her time and place meant a free person of mixed European and African ancestry. The couple had a number of children together, but were not formally married. In 1812 James was sent to Lanark, Scotland, to be schooled. It is also believed that he went to school in Chester, England, where he learned to speak and write in fluent French.

At the age of sixteen Douglas left Britain to enter the fur trade in the employ of the North West Company. He left Liverpool for Lachine, Lower Canada (now part of Montreal) in the spring of 1819. From 1819 until 1820 Douglas was stationed at the Fort William, Ontario (now part of Thunder Bay) as a clerk. In 1820 he was transferred to Île-à-la-Crosse on the Churchill River in northern Saskatchewan. The Hudson's Bay Company (HBC) was also active in this area and Douglas was caught up in at least one confrontation with the rival fur traders. At this post Douglas continued a policy of self-education by reading books brought over from Britain and meeting with many First Nations people.

In 1821 the North West Company was merged into the Hudson's Bay Company and Douglas' contract was placed onto the HBC's payroll. He quickly moved up the strict structure of the company, and in 1825 was put in charge of the foundation of the Fort Vermilion trading post in what is now northern Alberta. He was then stationed at Fort St. James on Stuart Lake, headquarters of the Company's New Caledonia District. In 1827 he established Fort Connolly on Bear Lake. On April 27, 1828, Douglas married the daughter of New Caledonia's Chief Factor William Connolly, Amelia Connolly. Amelia's mother had been Cree. Douglas was very close to William Connolly, his superior. Connolly was impressed by Douglas' skills and they got along well, resulting in Connolly agreeing to the marriage between the two.

In 1828, while Douglas was in charge of Fort St. James in Connolly's absence, two Hudson's Bay traders were murdered with the help of a Stuart Lake native. In one of the most controversial moments of Douglas' life he marched into the village and seized the accused murderer. Unfortunately the exact events of the day are not clear. In some accounts Douglas shot the native in the head on the spot with everyone watching. In others, Douglas simply dragged him out of the village to be executed at a later time. Another story is that Douglas attempted to shoot the man in the head but missed and had to get his partners to beat the accused before dragging him out of the village. Various stories were passed around the area and Douglas soon acquired a negative reputation among the local First Nations. Connolly, fearing for Douglas' life, asked HBC Governor George Simpson to transfer Douglas elsewhere. He was thus moved to Fort Vancouver, headquarters of the Company's Columbia District, located near the mouth of the Columbia River in present-day Washington. His wife joined him after the death of their first child in 1830. While in Fort Vancouver she gave birth to ten more children (five died in infancy).

Douglas spent nineteen years in Fort Vancouver, serving as Chief Accountant until 1834 when he was promoted to Chief Trader of the post. This was a very important position - only held by four others in the District. He received his commission as one of "the gentlemen of the interior" on June 3, 1835 in York Factory upon joining the Council of the Northern Department. In 1838 Douglas was put in charge of the District. While occupying the position Douglas denounced slavery of natives and made settlement with the Russian American Company, which had been active in the northern coastal fur trade. In return for the leasing of fur trading territory on the northern coast from Mount Fairweather south to 54°40′, the Russian - American Company received 2000 otter pelts and a number of other supplies. He also created the Pugets Sound Agricultural Company in an attempt to bring more British into the Columbia River valley to overpower the American presence there.

In September 1840 he was awarded with a commission as Chief Factor, the highest possible rank for field service with the HBC. As Chief Factor his first major contribution was to go on a personal visit south to California, where he met with a Mexican administrator and received permission to create a trading post in San Francisco. In 1841 Douglas was charged with the duty of setting up a trading post on the southern tip of Vancouver Island, upon the recommendation by George Simpson that a second line of forts be built in case the Columbia River valley fell into American hands (Oregon boundary dispute). Charged with this task, Douglas founded Fort Victoria, on the site of present day Victoria, British Columbia. This proved beneficial when in 1846 the Oregon Treaty was signed, extending the British North America/United States border along the 49th parallel from the Rockies to the Strait of Georgia.

In 1849 Britain leased the entirety of Vancouver Island to the HBC with a condition that a colony was to be created. Douglas moved the headquarters of the western portion of the Company from Fort Vancouver to Fort Victoria. He was not initially appointed to be Governor of the Colony of Vancouver Island - the position instead went to Richard Blanshard, an English barrister. However, most practical authority rested with Douglas, as the chief employer and person in charge of its finances and land, and he effectively drove Blanshard from the position. Douglas acknowledged the Royal Proclamation of 1763 and had a policy to trade the natives for their land. Costs for each parcel of land were usually in the form of blankets, often three for each man. This policy also stemmed from a desire to have good interactions with natives while avoiding violence. After the resignation of Blanshard in 1851, the British Government appointed Douglas as the Governor of Vancouver Island. However, he was still Chief Factor of the HBC, which led to a number of years of balancing the important and time consuming duties of both positions and was often the subject of controversy in local political debates and editorial tirades.

As Governor, Douglas faced a number of significant challenges, not least of which was the expansionist pressure of the neighbouring United States of America. Using his meagre resources, Douglas created the Victoria Voltigeurs, Vancouver Island's first militia, using money from the Company and composed of Metis and French-Canadians in the company's service. He also used the sparse presence of the Royal Navy for protection. During the Crimean War, in 1854, the British and French carried out an attack on Petropavlovsk and casualties were sent to Victoria. After facilities of this key port proved inadequate the British government charged Douglas with the creation of a hospital at Esquimalt harbour along with the improvement of Royal Navy supply capacity. This base proved to be important and successful when in 1865 the headquarters of the North Pacific Squadron were moved to Vancouver Island.

In 1859, Douglas also found his colony embroiled in a dispute with Washington Territory over sovereignty in the San Juan Islands. The protracted, twelve year standoff came to be known as the Pig War. Douglas pressed Britain to exert sovereignty over all islands in the archipelago dividing the Strait of Georgia from Puget Sound. Named for the largest island of the group, the San Juan Islands are immediately adjacent to Victoria and so were of great strategic interest and worry. While opposing troops remained garrisoned on San Juan Island, the dispute was eventually settled by arbitration in favour of the USA.

Douglas' largest problem in the mid- and late-1850s concerned relations with the majority First Nations population - numbered at around 30,000 local Songhees, Cowichan, Nanaimo, Nuu-chah-nulth, including raiding Haida from the Queen Charlotte Islands and the Euclataws Kwakiutl of northern Georgia Strait and the Sechelt, Sḵwxwú7mesh, and Sto:lo peoples of the Lower Mainland. In contrast, Europeans in the Colony numbered under 1000. Meanwhile, in neighbouring Oregon and Washington Territory the Cayuse and Yakima Wars and other conflicts between Americans and indigenous peoples were raging. Douglas' relations towards First Nations peoples were mixed. On the one hand, Douglas' wife was Cree, he had established many close business and personal relationships with indigenous peoples as a fur trader, and he sought to conclude treaties (the Douglas Treaties) with First Nations on southern Vancouver Island. On the other hand, Douglas supplied Washington Territory's Governor Isaac Stephens with arms and other supplies to assist the American government in its conflict with Native American tribes, and the treaties he concluded were later criticized as having provided woefully inadequate compensation in return for large swaths of territory (in most cases, a few blankets or a few shillings). The treaties, concluded between 1850 and 1854, acquired fourteen parcels of land for the Crown from the native peoples, totalling 570 km². The treaty making was halted after the Colony ran out of money to pursue its expansion policy.

Other actions during Douglas' time as governor include the creation of public elementary schools, attempts to control alcohol and the construction of the Victoria District Church (forerunner to the Christ Church Cathedral). In 1856, as ordered by the British Government, Douglas reluctantly established an elected Legislative Assembly. This was a turning point for Douglas, who was accustomed to administering the colony with absolute authority. The council was opposed to Douglas on many issues, and consistently criticized him for having a conflict of interests between the Company and the colony.

In 1856 gold was discovered in the Thompson River, a tributary of the Fraser River, and a year later in the Fraser River itself. This sparked an influx of miners and others, as word of the discoveries spread south to the United States. Thousands of Americans flooded into British Columbia, beginning the Fraser Canyon Gold Rush. Douglas, although he had no political authority on the mainland, felt compelled to exert British jurisdiction over the territory, and stationed a warship at the mouth of the Fraser in order to issue licences to prospectors and merchants. A major task during the huge inflow of settlers was to prevent violence between the recent arrivals and the local natives. Due to the Indian Wars, American animosity against natives was often high. In the fall of 1858, escalating tensions between the miners and the Nlaka'pamux people of the central area of the canyon broke into the Fraser Canyon War.

Douglas' actions in asserting British sovereignty over the mainland is generally conceded today to have helped exert control over American miners, and undermine American territorial ambitions toward this part of British North America. Shortly thereafter, the Colonial Office formally ratified Douglas' proclamation of sovereignty and established a new colony encompassing the mainland.

In 1858 the British Parliament created the Colony of British Columbia, and appointed Douglas as Governor. It was after this act that Douglas was asked to resign as Chief Factor of the western portion of the Hudson's Bay Company. The Company's trade monopoly on the mainland was not renewed, and neither was Douglas' position as Chief Factor. A judge, Matthew Baillie Begbie (the so-called "hanging judge"), was sent out to help Douglas maintain order and uphold British law in the area. Along with the judge came a contingent of Royal Engineers, to construct the infrastructure (mainly roads and bridges) needed to help open the resources of the land to be exploited by the colony. Soon after his appointment as Governor, Douglas was awarded with an appointment as a Commander of the Order of the Bath in recognition of his service as Governor of Vancouver Island.

In August 1858 news reached Douglas that two Vancouver Island miners had been killed by natives. He believed that the whole region was on the verge of war and went out to investigate. There had been numerous minor clashes between natives and whites but they had not yet resulted in death. After investigating the situation he found that alcohol had been a major cause, and prohibited the sale of liquor to natives. While on the trip to the murder scene Douglas brought the Crown Solicitor of Vancouver Island in order to uphold the law and make a show that pronounced that British law was still in effect. During this trip he encountered a great number of squatting foreigners, reducing the total possible revenues for land sales to the government.

In attempt to keep unlawful acts as infrequent as possible Douglas appointed regional constables, a Chief Inspector of Police (Chartres Brew), and a network of intelligence officials. He also created Assistant Gold Commissioners (the Chief Gold Commissioner was also Chartres Brew) to look after mining and civil cases. Such preventive measures helped ensure that the chaos accompanying the California gold rush was not repeated in British Columbia.

Continuing his service as governor of Vancouver Island, Douglas authorised construction of the government buildings known as the "Birdcages" in 1859. Then in 1862, with the discovery of rich gold deposits in the Cariboo region, sparking the Cariboo Gold Rush, Douglas ordered the construction of the Cariboo Road, an engineering feat running 400 miles from Fort Yale to Barkerville through extremely hazardous canyon territory. The Cariboo road was also called the "Queen's Highway" and the "Great North Road".

Near the end of his rule as Governor, Douglas was criticized for not changing the colony into a self-governing body. Instead, the only act of reform in this fashion was in the creation of an elected Legislative Council. His argument against the creation of a self-governing colony was the state of the population: few were British subjects, most did not hold permanent residence within the colony, and of those few owned property.

He was friends with Robert Ker the First Auditor General of the Two Colonies of British Columbia, and John Sebastian Helmcken a future Speaker of the House of the Legislative Assembly of British Columbia, both of whom, like Douglas, are considered founding fathers of British Columbia. Helmcken married Douglas' daughter Cecilia.

When his service to the Empire ended, Queen Victoria increased his position in the Order of the Bath to Knight Commander. Upon his retirement Douglas was honoured with banquets both in Victoria and New Westminster, the capital of the mainland. He also received a thank you on paper signed by 900 people. In 1864 and '65 Douglas toured Europe. He visited relatives in Scotland and a half-sister in Paris. However, he had to come home after his daughter, Cecilia, died.

Douglas kept an active lifestyle but stayed out of politics in all forms. He died in Victoria of a heart attack on August 2, 1877 at the age of 73. His funeral procession was possibly the largest in the history of B.C. and he was interred in the Ross Bay Cemetery.