Forex Currency Pair And How They Work
Forex is always traded in pairs. This is because the forex trader is simultaneously buying one currency and selling another. The currency pair itself can be thought of as a single unit, an instrument that is either bought or sold. Examples are the euro and US dollar (EURUSD), or the British pound and Japanese yen (GBPJPY).
What Is a Currency Pair?
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 or counter currency.
Currency pairs compare the value of one currency to another—the base currency (or the first one) versus the second or the quote currency. It indicates how much of the quote currency is needed to purchase one unit of the base currency. Currencies are identified by an ISO currency code, or the three-letter alphabetic code they are associated with on the international market. So, for the U.S. dollar, the ISO code would be USD.
How do Currency Pairs work?
Each forex pairs will have a market price associated with it, that is called the exchange rate. An exchange rate is simply the ratio of one currency valued against another currency.
For instance, the EURUSD exchange rate indicates how many euros can purchase one U.S. Dollar. All the currencies are always quoted in pairs, thus for every transaction in the Forex market, you are simultaneously purchasing one currency and selling another. Therefore, If we assume the price of the EURUSD currency pair is 1.1458, this means that one has to pay 1.1458 US dollars to buy one euro.
On the other hand, to find out how many euros it costs to buy one US dollar, simply flip the pair to USDEUR by dividing 1 by 1.1458 (1/1.1458=0.8727) which equals 0.8727. Therefore, one has to pay 0.8727 Euros to buy one US dollar.
Formula:
EURUSD: 1.1458
USDEUR: (1/1.14580) = 0.8727
For all the currency pairs, the first currency on the left is called “base currency”, and the one on the right is the “counter currency”. When buying (going long), the exchange rate indicates how much you have to pay in the units of counter currency to buy one unit of the base currency. On the other hand, when selling (going short), the exchange rate indicates how many units of counter currency you will receive for selling one unit of the base currency. The base currency is the “basis” for the buy or the sell.
Symbols in the FX market
The Forex market uses symbols to designate specific currency pairs. The United States dollar is symbolized by USD, the Euro is shown as EUR, and so the Euro vs the US dollar pair is shown as EURUSD.
Below is the list of other commonly traded currency symbols:
- Australian dollar = AUD
- British pound = GBP
- Swiss franc = CHF
- Canadian dollar = CAD
- New Zealand dollar = NZD
- Japanese yen = JPY
The price of the currency pair constantly fluctuates, as transactions occur around the globe, 24-hours a day, 5 days a week. There are many currencies that one could trade in the forex market. These currencies are generally categorized into three different categories such as major, minor and exotic currencies.
Major, Minor, and Exotic 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.
Major currencies
Major currencies are the most traded currencies in the FX market. They are generally sufficiently liquid to be readily convertible to the currency of other nations. Major currency is most often associated with politically stable, highly industrialized nations.
- USD (United State Dollar)
- EUR (Euro)
- JPY (Japanese Yen)
- CAD (Canadian Dollar)
- GBP (Great Britain Pound)
- CHF (Swiss Franc)
- AUD (Australian Dollar)
- NZD (New Zealand Dollar)
These 8 currencies are the currencies against which most other world currencies are valued. Major currency pairs refer to any pair containing one of the currencies listed above and the US Dollar, so while there are eight major currencies, there are only seven major currency pairs.
Minor Currency Pairs
Minor currency pairs include any two of the major currencies apart from the USD.
- EURJPY (Euro-Japanese Yen)
- EURGBP (Euro-British Pound)
- EURCHF (Eur0-Swiss Franc)
- CADJPY (Canadian Dollar-Japanese Yen)
- AUDJPY (Australian Dollar-Japanese Yen)
- GBPCHF (British Pound-Swiss Franc)
- GBPNZD (British Pound-New Zealand Dollar)
Exotic Currencies
Exotic currencies are any currencies not mentioned already. Some like the Hong Kong Dollar (HKD) and Norwegian Krone (NOK) are fairly liquid, some like the Mexican Peso (MXN) and Thai Baht (THB) are less liquid, and others like the Malawian Kwacha (MWK) and Laos Kip (LAK) have very little liquidity. Exotic pairs are those that include one major currency and one exotic currency. Below is the list of some of the exotic pairs:
- USDHKD (United State Dollar-Hong Kong Dollar)
- USDSGD (United State Dollar-Singapore Dollar)
- USDMXN (United State Dollar-Mexican Peso)
- USDTRY (United State Dollar-Turkish Lira)
- USDZAR (United State Dollar-South African Rand)
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