In Forex trading, currency pairs are the price quotes between two different currencies within the Forex (foreign exchange) market. The first mentioned currency is known as base currency and the second currency is the quote currency.
The forex currency pair compares the value of base and quote currency. It shows how much quote currency is needed to buy one base currency. All countries have different ISO Currency Codes that they are associated with in the international market. Like the United States uses USD for United States Dollars, Britain uses GBP for British pounds, and so on.
Comprehending Forex Currency Pairs
Currency pairs are traded in the foreign exchange market also known as forex, which is one of the most liquid and largest financial markets. This market deals with the buying, selling, and exchanging of currencies and is open 24 hours a day and 5 days a week including most of the holidays. It also deals with the conversion of currencies for international trade and investment.
When you buy a currency pair in the forex market, it means you buy the base currency and sell the quote currency. Similarly, when you sell the currency pair, you sell the base currency and buy/receive the quote currency. Simultaneous purchase and sale of currency pairs takes place in the forex.
Economic data relating to currency pairs, such as gross domestic product, interest rates, and economic growth affect the prices of the trading pair. The currency pair itself can be thought of as a single unit.
Currency pairs in Forex are quoted based on the bid (buy) and ask (sell) prices. The bid price is in which the broker buys the base currency in exchange for the quoted currency. The asking price is when the broker will sell you the base currency in exchange for the quote currency.
Types of Currency Pairs in Forex
There are three types of currency pairs:
- Major currency pairs
- Minor currency pairs
- Exotic currency pairs
1. Major Currency Pairs
A widely traded currency pair in Forex is the Euro against the US Dollar or shown as EUR/USD. It is the most liquid currency pair in the world because it is one of the most traded currency pairs in forex trading. The quotation EUR/USD = 1.2500 means that one euro is exchanged for 1.2500 U.S. dollars. In this case, EUR is the base currency and USD is the quote currency (counter currency). This means that 1 euro can be exchanged for 1.25 U.S. dollars.
There are as many forex currency pairs as there are currencies in the world. All currency pairs are categorized according to the volume that is traded daily for a pair.
The types of forex currencies that trade the most volume against the U.S. dollar are referred to as the major currencies, which include:
- EUR/USD or the Euro vs. the U.S. dollar
- USD/JPY or dollar vs. the Japanese yen
- GBP/USD or the British pound vs. the dollar
- USD/CNY or the U.S. dollars vs. the Chinese Yuan
- AUD/USD or the Australian dollar vs. the U.S. dollar
- USD/CAD or the Canadian dollar vs. the U.S. dollar
The last two currency pairs are known as commodity currencies because Canada and Australia are rich in commodities and both countries are affected by their prices. The major currency pairs tend to have the most liquid markets. The currency markets open on Sunday night and close on Friday at 5 pm U.S. Eastern time.
2. Minor Currency Pairs
Currency pairs that are not associated with the U.S. dollar are referred to as minor currencies or crosses. These forex pairs are not as liquid as the majors, but they are sufficiently liquid markets nonetheless. The crosses that trade the most volume are among the currency pairs in which the individual currencies are also majors. Some examples of crosses include the EUR/GBP, GBP/JPY, and EUR/CHF.
3. Exotic Currency Pairs
Exotic currency pairs are the third most traded in the forex market. These pairings include the combination of one of the 8 major currencies and a currency from a developing or emerging economy.
Exotic forex pairs can provide you with an opportunity to diversify your forex trading. Exotic currencies have a higher level of volatility, which increases the risk of trading them but also offers the chance of finding trading opportunities. Emerging market currencies offer a higher level of interest rate, which can make them attractive for carry trades.
An exotic currency pair would be formed with a combination of an exotic forex currency, such as the South African Rand (ZAR) or Swedish Krona (SEK), paired with a major currency, such as the Euro (EUR) or US Dollar (USD). These pairs can also feature an exotic against an exotic, such as the Turkish Lira (TRY) and Singapore Dollar (SGD).
How do Forex Currency Pairs work?
The currency exchange rates of foreign currency pairs float. In the floating rate, the exchange rate continually changes. The multitude of factors are the reason for these changes. The forex currency pairs serve to set the value of one vs. another. The exchange rates will continuously fluctuate due to the respective changing values. One currency will always hold stronger than the other.
The calculation for the rates between currency pairs is a factor of the base currency. A typical currency pair listing may appear as, EUR/USD 1.345. In this example, the euro (EUR) is the base currency, and the U.S. dollar (USD) is the quoted currency. One euro will trade for 1.345 U.S. dollars. In other words, the base currency is multiplied to give an equivalent value or purchasing power of the foreign currency.
For traders to make a profit, the euro exchange rate must increase. Alternatively, when a forex trader trades currency pairs like EUR/USD, they speculate that the value of the U.S. dollar will rise above the euro. The changes in currency exchange rates are known as the percentage-in-point movement (PIP).
Conclusion
The forex market has become the world’s most liquid and continuous market with trillions of dollars being traded daily. You can make lots of profit from it once you get to understand it better, and trading each time will make you good at it.
To do better at trading in the forex market, you have to go through the basic terms of currency pairs with which you will deal while trading. Once you get to know the nature of currency pairs and have a reliable broker, trading will become easier.