By Louis H-P on October 24, 2018Reading Time: 5 minutes
Currency trading pairs are what Forex trading is all about. Buying one currency and selling another is attractive as your holding can never go down to zero. The size and liquidity of the Forex market means this two-horse race between two currencies always has a buyer and seller. As the largest market in the world, Forex is open 24 hours a day, 5 days a week and provides many opportunities for aspiring traders.
Currency trading pairs are a quotation of two different currencies with one currency being quoted against the other. One currency is the base currency, usually the first, and the other is the quote currency. For example, when you see a value of GBP/USD 1.5, one British pound is worth $1.5. In simple terms you are betting that the base currency will appreciate versus the quote currency.
There are several benefits of trading currency trading pairs. With such a large market, liquidity is never a problem for the majors. Currency trading pairs are less volatile than stocks with tighter spreads but large moves must not be discounted. This makes it cheaper to trade them. The more regular but smaller moves, provides many trading opportunities but also less risk for aspiring traders, who will likely make mistakes. Not surprisingly, the most traded currency in the world is the US dollar. With the US economy being the largest in the world and a stable political system to boot, it is the de facto reserve currency of the world.
The US dollar is part of every major currency trading pair and should be on your currency watch list. If the US dollar is not part of a currency pair then it is not a major. The United States Dollar / Euro pairing is one of the most widely traded currency pairs due to its liquidity. It also has one of the lowest spreads from Forex brokers. As Forex trades go, it has less risk than other currency trading pairs. Being such an important currency pair there is a great deal of information out there to help you trade.
Other major currency trading pairs are the United States Dollar / Japanese Yen which has low spreads and exceptional liquidity. Also, the United States Dollar / Great British Pound. It is better known as Cable due to the undersea cables that used to carry bid and ask quotes across the Atlantic Ocean, before more modern means of communication were developed. Of the majors it is the most volatile. This can be attractive for a novice trader looking to trade something riskier but keen to stay with the tight spreads of a major currency pairing.
Currency pairs that do not include the U.S. dollar are called minor currencies or crosses. They have wider spreads and are less liquid. The more popular crosses are Euro / British pound, British pound / Japanese Yen and Euro / Swiss Franc. Other currency pairs to know of, are any involving the ‘Comdolls’: Aussie, Kiwi and Canadian dollar. The nickname is due to their economies being so reliant on exporting commodities and having dollar within their currency name.
Exotic currency pairings involve currencies which are small such as Euro / Turkish Lira or US Dollar / South African Rand. Also, many brokers will not offer data on them as these are less popular and it is not cost-efficient for them to do so
The biggest contributor to the movement of a currency is interest rates and their expectations. The USD is strong at the moment because of the tightening by the Fed, which is raising interest rates and guiding to keep doing so. This makes the USD more attractive because of the higher interest available on it. This gives a great deal of power to central banks such as the aforementioned Federal Reserve and the Bank of England.
Another influence is the popularity contest between currencies. If a country’s economy is stable and reliable whilst another suffers a short-term negative shock (For example Brexit for the UK economy) then this will affect the relationship between two currencies. This makes any move more pronounced in favour of the currency which is seen as strong and stable versus the one which is seen as unattractive.
When the world economy is trudging along without any controversy, you will usually see a ‘risk on’ phase. During such a ‘risk on’ phase, most currencies including minor ones will be in positive territory or will not suffer too much if their country’s economy releases bad news. In a ‘risk off’ scenario certain currencies exhibit ‘a flight to safety’ attraction, namely rise as a sell off occurs within markets. Two currencies in particular: The US dollar and the Swiss Franc.
USD usually goes up in a ‘risk-off’ mode as people rush to buy dollars to buy US 10 year T-bonds. Their safe-haven nature also appeals because the US dollar is considered the world’s reserve currency. Switzerland is as a model of stability.
One of the reasons that central banks are so closely involved with currencies is that they display the first signs of stress when a financial crisis is brewing. Stresses and the panic which slowly creeps in afterwards, is usually caused by political and economic news related to a country’s economy and therefore its currency. Ensuring that you stay aware of key economic news is important. Key movers and shakers are the Bank of England, The European Central Bank and the New York Federal Reserve.
Such economic news can also come from other parties such as the various finance ministries. The release of budget updates, new economic policies or the unemployment rate is important to the Forex market. Regular economic readings such as borrowing projections or the Non-farm payrolls are also followed by many market participants. These data points are routinely corrected in later months. Be aware they produce volatility when they are released!
Forex is such an important part of world markets that it’s influence must not be underestimated. The depreciation or appreciation of a currency can have a big influence on a country’s economy. Finding the best currency trading pairs is dependent on your trading plan and your level of experience. Novice Forex traders should stick to major currency trading pairs which offer a return but also less risk. Mastering currency trading pairs is the start of all Forex currency trading!