Forex currency pairs are the bread and butter of currency trading, forming the foundation of every trade and serving as the measuring posts for potential profit and loss. But what exactly is a currency pair and how exactly does this means of currency trading work? Let’s take a closer look…
An introduction to currency trading
Let’s start with the basics. At its most basic, forex trading is the buying of one currency and the subsequent selling of another – these two units make up our currency pair.
A trade is placed when a broker speculates one currency will rise or fall in value (strengthen or weaken) against another, buying or selling accordingly with the aim of making a profit from movement in foreign exchange rates.
What is a currency pair?
To readily judge the fluctuations in these values, one unit must be measured against another.
As such, a base currency is used as the foundation of the trade and is measured against the quote currency – this quote currency thus informs a trader of the value of that unit against 1 unit of the base currency. For example, if the USD/GBP pairing is trading at a market value of 1.1000, it means $1 is the equivalent of £1.30.
The base currency therefore acts as the informant for buying or selling a trade. In the aforementioned example, if a trader believed his USD base would strengthen against the GBP, he would buy the base (USD) and subsequently sell the quote (GBP).
To use some traders’ jargon, the buying of this base currency is a forex trading strategy known as ‘going long’ (hoping to profit from a rising pair). The selling of your base, on the other hand, is known as ‘going short’.
The most frequently traded pairs on the forex market are the majors. These 8 popular currencies all contain the USD within their pairings as either a base or quote, boasting the lowest spread and most liquid trades of any currency pairings. These 8 major currencies are:
- US dollar (USD)
- Great British pound (GBP)
- Euro (EUR)
- Japanese yen (JPY)
- Canadian dollar (CAD)
- Swiss franc (CHF)
- New Zealand dollar (NZD)
- Australian dollar (AUD)
Of all these majors, the EUR/USD pairing is the most commonly traded, accounting for almost 30% of all daily trades on the forex market.
Pairings that don’t trade with the USD are known as cross-currency or crosses.
With the USD historically acting as the base for all conversion rates (you can find out all about how and why this was the case right here), a currency would traditionally need to be converted into US dollars and then converted into the desired unit to establish a set exchange rate. With the introduction of cross-currency pairings, brokers are now able to offer a direct exchange rate.
The most popular of these crosses are pairings including the three major non-American currencies – the euro, the British pound and the Japanese yen. These pairings are more commonly referred to as ‘minors’.
Though the term may sound tantalising, exotic pairings are made up of currencies from smaller, emerging economies that subsequently lack liquidity within the market. As such, trading these pairings can often be more expensive. Popular exotic currencies include:
- Turkish lira (TRY)
- Swedish krona (SEK)
- Norwegian krone (NOK)
- Danish krone (DKK)
- South African rand (ZAR)
- Singapore dollar (SGD)
- Hong Kong dollar (HKD)
So there you have it
Now that you understand the inner workings of currency pairings, why not look to further expand your knowledge of the forex market by attending a free, expert-led seminar? You can sign up right here!