What is a currency pair? Forex trading for beginners
A currency pair is the quotation of two different currencies, with the value of one currency being quoted against the other. Currency trading is conducted in the foreign exchange, also known as the forex or “FX” market.
If you are starting to trade currencies in the Forex market, you are likely confused by all of the symbols and quotes blurring around on your screen. If you have done some research you would have seen the term pairs and wondered to yourself what on earth is a currency pair? When you trade in the forex market, you buy or sell in currency pairs.
A currency pair is the quotation of two different currencies, with the value of one currency being quoted against the other. The first listed currency of a currency pair is called the base currency, and the second currency is called the quote currency.
Forex currency pairs are written as XXX/YYY or simply XXXYYY. Here, XXX is the base currency and YYY is the quote currency. The currencies are listed as a three-letter code, which tends to be formed of two letters that stand for the region, and one standing for the currency itself. For example, GBP/ USD is a currency pair that involves buying the Great British pound and selling the US dollar.
Forex trading always involves selling one currency in order to buy another, which is why it is quoted in pairs. The price of a Forex pair is how much one unit of the base currency is worth in the quote currency. Essentially meaning how much currency you can purchase with another.
What is a base currency?
The base currency is the first currency listed in a forex pair. The base currency is the currency you are buying when you trade a Forex pair. If this Forex pair rises in value it means that the base currency has gained strength against the quote currency.
What is a quote currency?
The quote currency is the second currency listed in a forex pair and is used as the reference against the base. The base currency is the currency you are selling when you trade a Forex pair. If this Forex pair decreases in value it means that the quote currency has gained strength against the base currency.
If you buy a currency pair, you buy the base currency and implicitly sell the quoted currency. The bid (buy price) represents how much of the quote currency you need to get one unit of the base currency. Conversely, when you sell the currency pair, you sell the base currency and receive the quote currency. The ask (sell price) for the currency pair represents how much you will get in the quote currency for selling one unit of base currency.
Unlike the stock or commodity market, you trade currencies, which means you’re selling one currency to buy another. For stocks and commodities, you’re using cash to buy an ounce of gold or one share of Apple stock. Economic data relating to currency pairs – interest rates, gross domestic product (GDP) information, major economic announcements – affect the prices of a trading pair.
To keep things ordered, most providers split pairs into the following categories:
- Major pairs. Seven currencies that make up 80% of global forex trading. Includes EUR/USD, USD/JPY, GBP/USD and USD/CHF
- Minor pairs. Less frequently traded, these often feature major currencies against each other instead of the US dollar. Includes: EUR/GBP, EUR/CHF, GBP/JPY
- Exotics. A major currency against one from a small or emerging economy. Includes: USD/PLN, GBP/MXN, EUR/CZK
- Regional pairs. Pairs classified by region – such as Scandinavia or Australasia. Includes: EUR/NOK, AUD/NZD, AUG/SGD
Major currency pairs
There are as many currency pairs as there are currencies in the world. The total number of currency pairs that exist changes as currencies come and go. All currency pairs are categorized according to the volume that is traded on a daily basis for a pair. The currencies that trade the most volume against the U.S. dollar are referred to as the major currencies. All major pairs contain the U.S. dollar (USD) on one side and are the most frequently traded.
A widely traded currency pair is the Euro against the U.S. Dollar, also shown as EUR/USD. It’s actually the most liquid and most heavily traded currency pair in the world. 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. Another way of looking at this is that it will cost you $125 to buy EUR 100.
All of the major currency pairs have very liquid markets that trade 24 hours a day every business day, and they have very narrow spreads.
Minors currency pairs
Currency pairs that are not associated with and do not contain the U.S. Dollar (USD) are referred to as minor currencies or crosses. These pairs have slightly wider spreads and are not as liquid as the majors, however, they are still very liquid markets nonetheless. The most actively traded minor pairs are derived from the three major non-USD currencies: EUR, JPY, and GBP. Some examples of crosses include the EUR/GBP, GBP/JPY and EUR/CHF.
Exotic currency pairs
Exotic currencies pairs include the currencies of emerging markets, such as Brazil, Mexico or Hungary. These pairs are not as liquid, much more volatile and the spreads are much wider. An example of an exotic currency pair is the USD/SGD (U.S. dollar/Singapore dollar).
Keep in mind that these pairs aren’t as heavily traded as the “majors” or “crosses,” so the transaction costs associated with trading these pairs are usually bigger.
It’s not unusual to see spreads that are two or three times bigger than that of EUR/USD or USD/JPY. So if you want to trade exotics currency pairs, remember to factor this in your decision.