What is a Currency Pair?
When two currencies are quoted against one another, the result is called a currency pair. The term “base” refers to the first currency in a currency pair, while “quote” refers to the second currency that serves as a benchmark.
To facilitate transactions on the foreign exchange (Forex) market, the national currencies of two countries are paired together. The trade’s position will be based on the prevailing exchange rate between the two currencies. Currency pairings are used in all dealings within the foreign exchange market, including buying, selling, and trading.
What is a Currency Pair?
A currency pair shows how much one currency is worth in relation to another. Examples of currency pairs are the British pound (GBP) and the US dollar (USD).
Around the world, people use about 170 different currencies. This means that there are over 28,000 possible pairs, but most trades are made between just a few. People or traders buy and sell currency pairs on the foreign exchange market.
‘Base’ and ‘quote’ currencies make up each exchange pair. The base currency is what the seller wants to buy and the quote currency that they will use to buy it. The quote amount of money is always written on the right. When a dealer buys the EUR/USD pair, for example, they are trading dollars for Euros.
After the pair, there is a price quote that tells you how much of the quote currency you need to buy one unit of the base currency. If the EUR/USD exchange rate is 1.14282, this means that a seller could buy €1 for $1.14282.
There are three factors the drives the value of one currency against another and fluctuates regularly, namely economic performance, central bank interest rates and trading volumes.
How does Currency Pairs Work?
Foreign currency pair exchange rates are floating, which implies that they are always changing. Numerous things may have caused these alterations. The purpose of currency pairs is to establish the relative values of each, and the exchange rates will fluctuate over time in response to these shifting values. One currency will always keep its value better than the other.
The base currency is taken into account when determining the exchange rates between foreign currency pairs. The listing for a typical currency pair may read EUR/USD 1.3045. In this instance, the base currency is the euro (EUR), and the quote currency is the dollar (USD). There is a ratio price between the two currencies, one euro will exchange for 1.3045 USD.
The euro exchange rate needs to rise for traders to profit. In contrast, a forex trader who shorts the EUR/USD currency pair is betting that the US dollar will gain value over the euro. The percentage-in-point movement (PIP) is the term used to describe fluctuations in currency exchange rates.
Although a lot of forex trading occurs over a single trading day, you can hold a currency pair for days, weeks, months, or even years.
What Types of Currency Pair do you get?
You basically get three main categories for currency pairs, namely major, minor and exotic.
Major forex pairs
Major currency pairs trade the US dollar, which is the most traded currency in the world, for other currencies that are also very traded. Because they include the world’s most traded currencies from mostly stable countries, these pairs tend to be less volatile than their minor and exotic peers.
A low “bid-ask spread” makes them easy to buy. This is the difference between how much a broker will sell a pair for and how much they’ll buy it for. If, for example, the bid-ask spread would be $0.00016, the EUR/USD pair could be bought on a market for $1.08806 and sold for $1.08822.
The four major pairs that have the highest trading volumes are:
- EUR/USD currency pair which accounted for over a fifth (22.7%) of all forex trades. The pair represents two of the largest economies in the world: the US, and the European Single Market. Because both currencies are so widely used, the pair has high ‘liquidity’, which refers to how quickly and easily this currency, can be bought and sold. It also tends to have a low bid-ask spread, since it’s easy to find buyers and sellers.
- With the GBP/USD currency pair, traders exchange dollars for British Pounds and it basically makes up around 9.5% of daily forex transactions.
- The USD/JPY currency pair exchange Japanese Yen for US dollars and the Yen is Asia’s most widely-traded currency, which means it offers high levels of liquidity.
- The USD/CHF currency pair comprises the US dollar and Swiss franc. This is a very popular option for traders, since the Swiss financial system is considered a safe haven and the Swiss franc always tends to remain relatively stable.
Additional currency pairs that some traders may also consider ‘major’ are:
- EUR/GBP since the relative value of pounds and Euros has become more difficult to predict in recent years, since the ties between the two currencies have loosened since the UK left the European Union and European Single Market.
- The USD/KRW currency pair trades the US dollar against the South Korean Won which is the fourth largest currency in Asia. This pair rose in popularity following the rapid development of South Korea in the 1960s.
Minor forex pairs
In ‘minor’ currency pairs Euros (EUR), British pounds (GBP), or Japanese yen (JPY) are traded against each other, or a smaller currency. Although these pairs are popular, they experience lower trading volumes than major pairs.
Some of the more popular minor pairs include:
- EUR/JPY – Euros and Japanese Yen
- GBP/AUD – British pounds and Australian dollars
- GBP/JPY – British pounds and Japanese Yen
- GBP/CHF – British pounds and Swiss francs
- AUD/CAD – Australian dollars and Canadian dollars
‘Exotic’ and other forex pairs
“Exotic” currency pairs connect a currency from an emerging economy with a currency that is traded more frequently. These pairs typically have a somewhat large bid-ask spread since emerging market currencies are less liquid and less frequently traded.
In contrast to the EUR/USD pair’s $0.00016 spread, buying the USD/HKD pair might have a bid-ask spread of roughly $0.0050.
Prices are frequently erratic because political and economic developments can cause a currency’s value to change drastically very rapidly. The ‘exotic’ currency in these pairs is not frequently traded, therefore each trader’s actions can also have a substantial impact on the market’s mood.
Some of the most popular exotic pairs are:
- GBP/SGD – British pound and the Singapore dollar
- USD/HKD – US dollar and Hong Kong dollar.
- USD/TRY – US dollar and the Turkish lira
- EUR/MXN – Euro and Mexican peso.
Trading in Currency Pairs
Fixed contract sizes, also known as lot sizes, or multiples thereof, are used in currency trading of which 100,000 units is the typical lot size. Additionally, a majority of retail trading companies provide 1,000-unit (micro lot) and 10,000-unit (mini lot) trading accounts.
The rate that is officially quoted is a spot price. However, in a trading market, currencies are sold at an asking price, also known as the offering price, and traders wishing to buy a position aim to do so at their bid price, which is always less than the asking price. The spread refers to this price difference.
For instance, the spread is US$0.0002, or 2 pip, if the EUR/USD quote is 1.3607/1.3609. Markets with significant liquidity typically have spreads that are narrower than markets with fewer transactions.
Instead of a major international forex market maker, a brokerage company will provide a retail customer with an account a higher spread that varies between brokerages. Instead of charging a transaction fee, brokers generally raise the spread they get from their market makers in exchange for the service they give to the end user. Spreads are typically even higher at a bureau de change.
Costs involved in forex trading
Fees and commissions on forex trading are usually low due to high trading volumes and market activity. What you will pay depends on the broker you choose, and the pair you want to buy. The following fees are typically charged:
Commission – This is a small one-off fee some brokers charge for each transaction you make.
Spread – The ‘spread’ on a currency pair refers to the difference between the price at which a broker sells a pair, and the price at which they will buy it.
Swap fee – This is the interest you could pay for holding a forex pair overnight.
Inactivity fee – Some brokers charge a monthly inactivity fee when you haven’t executed a trade for a certain amount of time, usually 12 months.
Pros and Cons of a Currency Pair
Popular trading commodity
Lots of help available
Tight spreads which make them cost-effective
Market analysis always available
Difficult to predict price movements
Does not ensure a regular and fixed return
Possibility of overcrowding
Limits diversification opportunities
If two currencies are paired and one is worth less than the other, they are called a currency pair. The value of the British pound against the U.S. dollar is shown by GBP/USD.
Most of the time, people trade “major” currency pairs, which are those that include the U.S. dollar. You can also trade in both minor and exotic currency types.
There are many pairs of currencies, but not all of them can be sold on the Forex market. At the moment, 180 different coins are accepted by the United Nations.
A lot of traders, no matter how experienced they are, keep at least one big currency pair in their basket. Trading in important currencies is a good way to lower your risk and still have a chance of making money. You can start with EUR/USD or USD/JPY if you are a beginner and need help choosing a big currency. They are very steady, calm, and simple to understand, even if you haven’t traded much before.