A currency pair is a price quote of one currency relative to another currency. Currencies are paired where one currency is the base price and one is the quoted price. Forex quotes always involve currency pairs because a trader buys one currency by selling another.
For example, for a strong currency pair, one Euro (base price) will get you one USD and some change (quote price). For an exotic currency pair, one US Dollar will get you about R19.
EUR/USD (Euro/US Dollar) is the most liquid and consequently the most-traded currency pair on the market. In fact, EUR/USD makes up to a quarter (24-25%) of daily transactions on the forex market. EUR/USD is the most popular currency pair because it is representative of the two biggest economies in the world; the European single market and the United States of America.
Base currency versus quote currency
In a currency pair, the first listed currency is called the base currency. The second currency is called the quote currency. The pair indicates how much of the quote currency is needed to buy one unit of the base currency.
- The base currency is always the first currency in the pair. It’s also called the transaction currency.
- The quote currency is the second currency in the pair. It’s also called the counter currency.
Example: EUR/USD 1.2500
EUR is the base currency and USD is the quote currency.
1 Euro can be exchanged for 1.25 US Dollars.
When you trade currency pairs, you buy the base currency (EUR) and obliquely sell the quoted currency. By obliquely we mean you don’t actually own the currency, you’re merely taking a position on the price movement in the hope of making a profit.
The bid price is how much of the quote currency you need to get one unit of the base currency. In other words, what you buy the base currency for. A bid is a price an investor or trader is will to pay to buy a currency.
The asking price is how much quote currency you will get for selling one unit of the base currency. In other words, the price a seller is willing to accept for the currency. The asking price will always be higher than the bid price.
What is the ISO currency code?
Currency pairs compare the value of the base currency versus the quote currency. The value is identified by an ISO currency code or the three-letter alphabetic code they are associated with on the international market.
ISO currency codes for the Top 8 currencies in the world are:
USD US Dollar
GBP British Pound
CAD Canadian Dollar
CHF Swiss Franc
NZD New Zealand Dollar
AUD Australian Dollar
JPY Japanese Yen
How currency pairs work on the forex market
Currency pairs are either traded on the foreign exchange market or over-the-counter (OTC). The forex market is the largest and most liquid market in the financial world, making it the most traded market. An estimated USD 5 trillion is traded on average every day, 24-hours a day, five days a week.
To compare, forex trading volumes exceed global equities trading by 25 times.
The vast majority of currency pairs are traded over-the-counter using advanced forex trading platforms via a broker’s server. This means trading takes place remoted via electronic platforms or telephone links to banks and brokers. The most popular trading platform for forex is MetaTrader 4, with over 95% of brokers offering in on their servers.
Only about 3 percent of forex is traded on the foreign exchange market in the form of futures and options contracts. Foreign exchange markets are made up of banks, forex brokers, central banks, investment management firms, and hedge fund firms.
Currency pairs are not only traded for profit. They have also been used to convert currencies for international trade and investment.
Trading foreign currency is different from trading stocks and commodities. With forex, you sell one currency to buy another. With stocks and commodities, you buy an ounce of gold or one share of a company for the current value of the share.
The Top 8 most-commonly traded currency pairs in the world
The most traded currency pairs in the world are called the Majors. They make up the largest share of the forex market, representing about 85% of daily transactions. They are characterized as having high market liquidity.
High market liquidity means an investor or trader can quickly dispose of or buy an underlying asset without causing a drastic change in the asset’s price. Liquidity is all about the trade-off between the speed of the sale and the price you’ll get for the currency.
In a liquid market, the trade-off is mild. In an illiquid market, the trade-off is massive because it’s more difficult to off-load the currency or convert it to cash. Bitcoin is an example of an illiquid currency.
The Majors are:
EUR/USD Euro/US Dollar
USD/JPY US Dollar/Japanese Yen
GBP/USD British Pound/US Dollar
AUD/USD Australian Dollar/US Dollar
USD/CHF US Dollar/Swiss Franc
NZD/USD New Zealand Dollar/US Dollar
USD/CAD US Dollar/Canadian Dollar
The Majors are often referred to by their nicknames, which denote national or geographic connotations.
Named when a communications cable under the Atlantic Ocean linked the London and the New York stock exchanges
Named after the Channel Tunnel that links Europe with Great Britain.
NZD/USD Kiwi or The Bird
USD: United States Dollar
The US Dollar is found in the majority of major currencies. Sometimes called the greenback, the USD is the first and foremost currency in forex trading. It’s the national currency of one of the most powerful trading nations in the world and is highly liquid, meaning it can almost instantly be converted into cash.
The USD is the unofficial global reserve currency and is held by nearly every central bank and financial institution on the planet. The USD is universally accepted and is often issued as an alternative currency to a country’s official local currency.
The US Dollar is often used as the intermediary in triangular arbitrage opportunity trading. This is a trading strategy that exploits arbitrage opportunities that exist among three currencies. Arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices at which the unit is traded.
The USD typically acts as a benchmark or target rate for countries that fix or peg their currencies to the value of the US Dollar. Often, developing countries will fix their currencies to the US Dollar to stabilize their exchange rates, rather than allowing the free forex markets to drive the currency’s relative value.
The USD is the currency used most often as the standard currency for global commodity trading. This includes crude oil and precious metals.
EUR: The Euro
The Euro is the second-most traded currency after the US Dollar. It’s the official currency for the Eurozone which is a geographic and economic region that consists of all the European Union (EU) countries that have fully incorporated the Euro as their national currency.
The Euro was introduced to the world markets on 1 January 1999 and banknotes and coins were issued for circulation three years later.
The nations of Europe and Africa commonly peg their currencies to the Euro to stabilize their own currency rate, in much the same way the USD is used. For this reason, the Euro has become the world’s second-largest reserve currency.
Widely used and a trusted currency, the Euro enjoys high liquidity and is often included in the Majors currency pairs. The EUR/USD is the most liquid currency pairing in the world where the EUR/USD offers low bid-ask spreads as well as constant liquidity for investors who want to sell or buy.
Political events within the Eurozone drive large trading volumes, more recent events in Italy, Greece, Spain, and Portugal, as well as the ongoing Brexit saga, have made the Euro the most politicized currency in the world.
JPY: Japanese Yen
The Japanese Yen enjoys high liquidity and the most traded Asian currency. It’s viewed by many traders as a representative of the strength of Japan’s manufacturing and export-driven economy.
Many forex traders look to the Yen as an indicator of the overall health of the Pan-Pacific region, in particular South Korea, Singapore, and Thailand. The currency of these countries is far less traded on the global forex market but represents the health of the rest of Asia.
The Yen is highly rated on the forex market for its role in the carry trade. A carry trade is a trading strategy that involves borrowing at a low-interest rate and investing in an asset that provides a higher rate of return.
The value of the Yen is largely determined by its relationship to the international interest rates of the US Dollar and the Euro. Considering the carry trade is such a large part of the Yen’s presence on the global forex market, the constant borrowing of the Yen has meant the currency does not enjoy a great deal of appreciation.
GBP: Great British Pound
Also known as the Pound Sterling, the Great British Pound is the fourth-most traded currency in the world. The GBP has remained the official currency of the United Kingdom, although the UK was an official member of the European Union (Britain has since exited the Eurozone in the dramatic Brexit saga).
Great Britain never adopted the Euro as its official currency for several reasons but it was mainly historic pride in the Pound Sterling. The other reason was for Great Britain to maintain control of its domestic interest rate.
The strength of the Pound Sterling is driven by the strength of the British economy and the political stability of its government. Due to its historic high relative value, the Pound Sterling also acts as an important reserve currency.
The GBP is an important currency benchmark for many nations and is highly liquid, meaning it can easily
CAD: Canadian Dollar
Nicknamed the Loonie, the Canadian Dollar is one of the foremost commodity currencies. It is typically moving in tandem with the commodities markets, in particular crude oil, precious metals, and minerals.
Canada is a major exporter of these commodities. As a result, its price fluctuations are a response to movements of the underlying commodity prices, most notably crude oil. Traders often use the Canadian Dollar for speculative trading on commodity price movements or to hedge positions in the commodity market.
Due to its proximity to the United States, the Canadian Dollar price closely correlates with the health of the US economy and its currency price fluctuations.
CHF: Swiss Franc
Nicknamed the Swissy, the Swiss Franc is regarded as a neutral currency or more accurately, a haven in the forex market. This is because the Swiss Franc moves differently to the more volatile commodity currencies such as the Canadian Dollar and Australian Dollar.
A haven is an investment that’s expected to retain or increase in value in volatile trading conditions. The Japanese Yen is another example of a safe-haven currency. Investors favor safe havens to limit their exposure to losses on market downturns.
The Swiss Franc is an active currency and typically trades within a relatively tight range. This helps it reduce volatility and keep the country’s interest rate in check.
AUD: Australian Dollar
Nicknamed the Aussie, the Australian Dollar is the official currency of the Commonwealth of Australia. This includes mainland Australia and its territories as well as Kiribati, Nauru, Tuvalu, and Zimbabwe. It’s the fifth most-traded currency in the world, representing up to 9 percent share of daily transactions on the global forex market.
The Australian Dollar is commonly paired with the US Dollar. Traders favor the AUD/USD pairing because it is high liquidity. Intraday traders often choose the AUD/USD pair to make a profit from short-term price fluctuations while other investors are attracted to it for its long-term capital appreciation.
Australia is a major exporter of coal and iron ore which means that its currency is heavily dependent on commodity prices. During a commodity slump when oil, iron ore and coal prices bottom out, the Australian Dollar tends to weaken significantly. Likewise, it strengthens when commodity prices are strong.
The AUD/USD pair is the fourth most-traded currency pair but it is not one of the Big 6 currencies that make up the US Dollar index.
NZD: New Zealand Dollar
Nicknamed the Kiwi, the New Zealand Dollar is another world currency that is strongly impacted by commodity prices. In contrast to the Australian Dollar, the NZD is closely linked to commodity price movements in agricultural commodities.
New Zealand is a top-five global exporter of dairy and holds a significant market share in the transportation of milk powder, butter, and cheese. Dairy exports represent over 21 percent of New Zealand’s total exports.
Besides, New Zealand is the fourteenth-largest supplier of agricultural goods to the United States, totaling some USD2 billion annually. This is why the NZD/USD pairing finds itself in the Top 8 of the most popular currency pairings in the world.
The NZD/USD pairing is also commonly used by traders to execute carry trades. This is where traders sell a currency and invest the proceeds into another currency that has a higher yield. Profit is gained from a carry trade from the difference in interest rates and through exchange rate fluctuations.
The Reserve Bank of New Zealand (RBNZ) takes an aggressive stance towards managing inflation. The NZD typically offers investors a higher prime rate than other global currencies. To compare; if the RBNZ has set the interest rate at 2 percent, the United States Federal Reserve (FED) will likely have set its rate at 5 percent.
The discrepancy between the interest rates is what makes the NZD/USD pairing so attractive to traders and investors, particularly those who follow a carry trade strategy on these two currencies.
Featured Writer on SA Shares, Forexsuggest and Forextrading.africa