What You Need To Know About Currency Pairs
Understanding currency pairs is a key element of successful forex trading. It’s all about buying one currency and selling the other, at a strategic price point calculated to minimise losses and maximise profits. Here are some essential points about currency pairs that every forex trader needs to know.
How do currency pairs work?
The values of the currencies are constantly fluctuating in response to market forces. A currency pair is the value of two different currencies quoted against each other. The base currency refers to the first listed currency of the pair, and the second listed is referred to as the quote currency.
The comparison of the pair allows the trader to see how much of the quote currency is needed to purchase the base currency. This forms the basis of the decision to buy or sell currencies in order to make a profitable trade on the foreign exchange, or forex market.
The forex markets enables the conversions of currencies for international trade and investment purposes, and also allows currencies to be bought, sold, and exchanged on a speculative basis. Instant forex funding is available with a low barrier of entry to anyone who wishes to trade, and the markets are open almost 24/7.
The buyer transaction process involves buying the currency and selling the quote currency, and the seller process involves selling the base currency and buying the quote currency. The bid price is the buying price, and the ask price is the selling price.
All currencies are identified by a three letter alphabetic code, e.g. USD for US dollars, known as the ISO (International Organization for Standardisation) Currency Code. The codes also have a corresponding three digit numeric code which is used for computer algorithms, although for trading purposes the currencies are quoted using the alphabetic code.
The ISO document states: “ISO 4217:2015 specifies the structure for a three-letter alphabetic code and an equivalent three-digit numeric code for the representation of currencies. For those currencies having minor units, it also shows the decimal relationship between such units and the currency itself.”
It adds: “ISO 4217:2015 is intended for use in any application of trade, commerce, and banking, where currencies and, where appropriate, funds are required to be described. It is designed to be equally suitable for manual users and for those employing automated systems.”
The full listing of ISO codes was established in 1978, and can be found on their website. The base and quote currencies are listed together thus: USD/EUR. The United Nations recognises 180 currencies that can be traded on the forex market, and if you do the maths to work out all the possible combinations, that’s. . .a lot.
What are the currency categories?
The three categories of currency pairs are the ‘majors’ the ‘minors’ (sometimes referred to as crosses) and the ‘exotics.’ Major currency pairs always include the US dollar (USD) and one of the other most commonly traded currencies of the world.
These include the Euro (EUR), the Japanese Yen (JPY), the Swiss Franc (CHF), the Australian dollar (AUD), the British pound (GBP), the New Zealand dollar (NZD) and the Canadian dollar (CAD). The Australian, New Zealand and Canadian currencies are referred to as commodity currencies, because both countries are rich in commodities, such as coal, oil, and metals.
Major currency pairs
The currency pairs which are most often traded together are the majors, and they have the most liquidity, which refers to how quickly and easily the currency can be bought and sold on the markets. This means there is less risk associated with trading these currencies, because there are generally always buyers and sellers to be found.
There is some variation of liquidity even within the major currency pairs. For example, the USD/EUR is one of the most liquid pairs in the world, while the AUD/USD or the NZD/USD are less liquid, as they are from smaller or more specialised economies.
Minor currency pairs
The minor currency pairs are those pairs which are from the major currencies, but which don’t include the US dollar. For example, they may be a pairing of the British pound and the Eurozone (GBP/EUR), but as a result of not being paired with the USD, they will have less liquidity on the market.
You may also hear of minor pairs referred to as crosses or cross currencies. A cross currency means any currency which does not contain the USD, as opposed to a minor, which is a pair not including the USD, but which are still from a major economy.
The most often traded minors included currencies from the three major economies of Japan, the UK and the Eurozone. Minors are the most traded pairs after the majors. While they still offer profitable opportunities for traders, it’s important to do some careful market analysis before making your move with the minors.
Exotic currency pairs
Exotic currency pairs refer to a pair from a combination of a developing or emerging country or economy, and a major currency. An example of this would be the South Africa Rand (ZAR) and the USD. It could also be a combination that doesn’t include the USD, such as the Euro and the Swedish Krona (SEK).
Two exotics can also be paired together, known as exotic v exotic, such as the Kuwaiti dollar (KWD) and the Singapore dollar (SGD). Exotics are traded less frequently than the majors or minors, and have less liquidity. They can be prone to more volatility, which makes them riskier, but also provides lucrative opportunities for the discerning trader.
Therefore, it is usually recommended that only experienced forex traders trade the exotics. However, with some research and preparation, it is quite possible to successfully trade the exotics.
Advantages and disadvantages of trading minors
While most newbie traders are advised to begin with the majors, there can be advantages to trading minors. They are most suited to those with a medium- or long-term trading strategy, rather than a short day trader.
Those who are skilled at close market analysis are best suited to the minors, as it is possible to spot highly profitable trades in a less competitive and crowded arena than in the majors. However, it can be harder to get out of a less profitable trade, for example when there are delays in obtaining prices, so this requires careful vigilance.
If you have enough capital and a flexible enough risk tolerance to withstand some occasional losses and slippage, then trading the minors could be well worth your time. Th best strategy is to identify consistent long term trends and patterns in the market, and pay attention to economic data releases for your chosen currencies.
Advantages and disadvantages of trading exotic currency pairs
Exotic currency pairs from developing and emerging markets are still affected by changes to the USD, so it’s important to keep an eye on the economic calendar for the latest relevant data releases. However, in general, they are not as sensitive to general market forces as other types of currency.
Exotics are a lot less liquid than the majors and minors, so it is more difficult to achieve a target price zone. They may require more capital to make up for higher spreads, and are prone to sudden rapid devaluation. Therefore, they are considered riskier to trade with than other currency pairs.
However, the greater volatility of the exotics also leads to significant opportunities for the discerning trader.
Some exotic pairings are more profitable and reliable than others, so if you want to have a try, it’s worth starting off with the more popular pairs, including the JPY/NOK (Japanese Yen/Norwegian krone), the AUD/MXN (Australian dollar/Mexican peso), the EUR/TRY (the Euro and the Turkish lira) and the USD/THB (the US dollar and the Thailand baht).
Trading an exotic against a strong major, particularly the USD, is a good strategy which yields more predictable results than other pairings. This is because the USD is so powerful, that it can sway the price of smaller currencies in its wake, making it easier to trade off the back of market swings.
If you live a country which has an exotic currency and speak the native language, you are also better placed to trade with that currency, because you are able to observe at close hand the economic factors which might influence the price movements, and have knowledge of them before the rest of the world takes note.
If you are thinking of trading an exotic but you don’t speak the native language, be aware that any information you receive may be out of date, second hand, and/or poorly translated. Trading two exotics against each other is even more of a risk, and you may find that brokers are unwilling to offer leverage for this in any case.
Currency pairs fall into three categories: major, minor, and exotic. The major currency pairs always include the USD, and have high liquidity, meaning that they move large quantities of currency on a daily basis. This makes them easier and less risky to trade than minors and exotics, so if you are new to forex trading, the usual advice is to stick with the majors.