Understanding Currency Pairs
Understanding Currency Pairs
All transactions made on the forex market involve the simultaneous buying and selling of two currencies.
This ‘currency pair’ is made up of a base currency and a quote currency, whereby you sell one to purchase another. The price for a pair is how much of the quote currency it costs to buy one unit of the base currency. You can make a profit by correctly forecasting the price move of a currency pair.
Broker offers hundreds of combinations of currency pairs to trade including the majors which are the most popular traded pairs in the forex market. These include the Euro against the US Dollar.
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| Currency Pair |
The diagram above looks at the most traded currency pair (EUR/USD) in the forex market and breaks down its essential components
For most currency pairs, a pip is the fourth decimal place, the main exception being the Japanese Yen where a pip is the second decimal place.
On the forex market, trades in currencies are often worth millions, so small bid-ask price differences (i.e. several pips) can soon add up to a significant profit. Of course, such large trading volumes mean a small spread can also equate to significant losses.
Trading forex is risky, so always trade carefully and implement risk management tools and techniques.
Difference between long and short positions
A long position means a trader has bought a currency expecting its value to rise. Once the trader sells that currency back to the market (ideally for a higher price than he or she paid for it), their long position is said to be ‘closed’ and the trade is complete.
If you wanted to open a long position on the Euro, you would purchase 1 Euro for USD 1.1918. You will then hold your position in the hope that it will appreciate, selling it back to the market at a profit once the price has increased.
A short position refers to a trader who sells a currency expecting its value to fall and plans to buy it back at a lower price. A short position is ‘closed’ once the trader buys back the asset (ideally for less than he or she sold it for).
In this case, if you think the Euro will weaken against the Dollar, you will sell 1 Euro for USD 1.1916 and hold a short position. You expect the Euro to depreciate and plan to buy it back at a lower rate.
What are the most traded currency pairs on the forex market?
There are seven major currency pairs traded in the forex market, all of which include the US Dollar in the pair.
You can also trade crosses, which do not involve the USD, and exotic currency pairs which are historically less commonly traded (and relatively illiquid).
This means they often come with wider spreads, meaning they’re more expensive than crosses or majors.
Major currency pairs are generally thought to drive the forex market. They are the most commonly traded and account for over 80% of daily forex trade volume.
There are four traditional majors – EURUSD, GBPUSD, USDJPY and USDCHF – and three known as the commodity pairs – AUDUSD, USDCAD and NZDUSD.
These currency pairs typically have high liquidity, which means they tend to have lower spreads. They are associated with stable, well managed economies and are less prone to slippage, where the expected price of a trade differs from the price the trade was executed at.
Cross currency pairs, known as crosses, do not include the US Dollar. Historically, these pairs were converted first into USD and then into the desired currency - but are now offered for direct exchange.
The most commonly traded are derived from minor currency pairs and can be less liquid than major currency pairs. Examples of the most commonly traded crosses include EURGBP, EURCHF, and EURJPY.
Exotics are currencies from emerging or developing economies, paired with one major currency.
Compared to crosses and majors, exotics are traditionally riskier to trade because they are more volatile and less liquid. This is because these countries’ economies can be more susceptible to intervention and sudden shifts in political and financial developments.
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