Introduction to Currency Pairs
When two currencies are quoted together, the value of one currency is expressed as a ratio to the other currency.
A currency pair’s base currency is the first currency listed, while the quote currency is the second.
The worth of one currency is measured against another in a currency pair, with one currency serving as the “base” against which the “quote” currency can be calculated.
How much of the quotation currency is required to buy one unit of the base currency is displayed.
ISO currency codes, the three-letter alphabetic code used to identify currencies on the international market, are assigned by the International Organisation for Standardisation. The ISO code for the U.S. dollar is USD.
KEY POINTS
- Exchange rates between two currencies are quoted as a “currency pair” in the foreign exchange market.
- To buy the first currency (the base currency) and sell the second currency (the quote currency) in a currency pair, an order must be placed for both currencies.
- The pair EUR/USD is the most traded currency pair in the world. The US dollar/Japanese yen pair is the world’s second most actively traded currency pair.
The Basics of Currency Pairs
The forex market, or foreign exchange market, is where traders swap one currency for another. It is the financial sector’s largest and most liquid market.
Currencies can be bought, sold, exchanged, and speculated on in this market. Currency exchange facilitates worldwide business and investment.
Large volumes of currency are traded on the foreign exchange market around the clock, five days a week (including most holidays).
While every forex deal requires the simultaneous acquisition and disposition of one currency, the currency pair itself can be seen as a standalone entity.
You acquire the quote currency from your forex broker and sell the base currency. When selling a currency pair, on the other hand, the base currency is sold and the quote currency is received.
Bid and ask prices are used to quote currency pairings. Your forex broker will buy your base currency at the bid price in return for the quote or counter currency.
The ask, also known as the offer, is the price at which the broker will buy your quote or counter currency in return for the base currency.
Selling one currency in order to purchase another is what currency traders do. When you buy a unit of a commodity or shares of a stock with cash, you are exchanging the cash for that commodity or those shares.
Currency pair prices are affected by macroeconomic indicators like interest rates and economic growth or GDP.
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Major Currency Pairs
The Euro vs the U.S. Dollar, or EUR/USD, is a frequently traded currency pair. Since it is the most actively traded currency pair in the world, it is considered the most liquid.
If you see the currency pair quoted as EUR/USD = 1.2500, it means one euro can be bought for 1.25 U.S. dollars right now.
The Euro is used as the “base” currency while the US Dollar is used as the “quote” or “counter” currency. In other words, you can get 1.25 dollars for every euro. You can also think of it as the price of buying 100 euros: $125.
There are as many possible combinations of currencies as there are currencies in circulation.
As different currencies rise and fall in popularity, the total number of available currency pairs fluctuates.
The volume of daily trading activity between any two currencies is used to classify all currency pairs.
Major currencies are those that are traded often against the U.S. dollar and include:
- EUR/USD (Eurodollar/U.S. dollar)
- USD/JPY (U.S. dollar/Japanese yen)
- GBP/USD (Great Britain pound/U.S. dollar)
- AUD/USD (Australian dollar/U.S. dollar)
- USD/CAD (Canadian dollar/U.S. dollar)
The remaining two currency pairs are classified as commodity currencies due to the shared commodity wealth between Canada and Australia.
The most active markets occur Monday through Thursday at all hours of the night and day for the major currency pairs.
Opening on Sunday evenings and closing at 5 p.m. Eastern Time on Fridays, U.S.
Minor and Exotic Pairs
Minor currencies, also known as crosses, refer to currency combinations that do not involve the U.S. dollar.
Even though these pairings have bigger spreads and less liquidity than the majors, they are nonetheless large and active markets.
Most frequently traded currency pairs are those whose component currencies are also majors. Currency pairs are often used to hedge against foreign exchange risk.
Principal risk management in forex trading: A must read
Currencies from developing nations are part of the exotic currency pairs. There is less volume in these pairings, and the spreads are greater.
The US dollar/Singapore dollar exchange rate is an unusual currency combination.
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