What are Currency Pairs and How do they Work?

In the Forex market, there are thousands of currencies available to buy or sell. They cover all the possible currency combinations from different countries. As a novice trader, it can be a minefield deciding which currency pair to trade. Where do you start? What are the important factors for choosing a currency pair to trade?

Every country has its own currency. It all becomes interesting when the currency of one country pairs up with the currency of another country. Each one is battling to rise or fall. The outcome depends on market sentiment and where traders are anticipating price action. And the volume of money traded on the buy or sell will create the movement. It’s a bit like a tug of war. At some point, one currency wins, and price action will move higher or lower.

Bear in mind, some countries don’t want their currency to be volatile and to increase in price. As we have mentioned before, it’s sometimes in the interest of a country to drive its currency down. A lower currency rate can assist in more profitable international trade and the economy of the country. This is often where the market makers come in and dump high volume trades to influence the price movement. Currencies respond to money in the market.

In many ways, each currency pair has a unique personality. Some pairs are more volatile than others. Some currency pairs are slow and move only a few pips a day. Other currency pairs are fast and make big price movements on most days. This is of course when a pair is trending and not in consolidation. This is when price action stays in a small range until the volume increases for direction.

Currency pairs seem to have unique patterns and behaviour. Understanding these patterns lies at the heart of the successful Forex trader.

Not all currency pairs are created equal. For novice traders, some currency pair price patterns can be harder to understand. Many new traders say that their trading improved once they focused on one or two pairs.  This is preferable to scouring the charts each day trying to find something interesting. Immersing yourself with one chart is a sure way to develop a sense of how a currency pair interacts with the market and price movement.

As you know, Traders buy and sell currencies through a broker. When you place a trade for a currency pair you are both buying one currency and selling another. That said, the currency pair is often thought of as a single unit.

Different currencies have different spreads. To check this, all you have to do is observe the difference between the buy (bid) price and the sell (ask) price. Let’s look at an example –

On the chart you see EURUSD quoted as 1.2145/1.2155 so you can see there isn’t much difference between the buy and sell price. This is a small spread

Then you look at GBPJPY and the price quoted for the pair is 1.3645/1.3685. This is a larger spread. If you placed an order at this price, your trade would already show a loss. Before you can make a profit, you have to overcome the bigger spread.

What is a Currency Pair?

A currency pair is the quotation of two different currencies, traded in the Forex market. The value of one currency is quoted against the other. The first currency (on the left in the pair) is the base currency. The second currency (on the right in the pair) is the quote currency.

So, currency pairs compare the value of one currency to the other – the base currency to the quote currency. It indicates how much of the quote currency a trader needs to purchase one unit of the quote currency.

Currencies are always displayed with a 3-letter acronym. For example, the U.S. dollar acronym is USD. For the sterling pound, it is GBP. All pairs are displayed as two 3-letter codes, like GBPUSD. In this instance, if you wanted to buy GBP, the price quote would be USD.

Imagine you wanted to buy GBPUSD. The pairs quote shows as 1.2145/1.2176. You are buying the sterling pound for 1.2176. If you were selling GBPUSD, you would be buying the U.S. dollar for the base currency price of 1.2145. If you expect the British pound price to rise, you are buying the base currency. And you are selling the quote currency.

If you expect the British pound price to fall, you are placing a trade to buy the U.S. dollar and selling the British pound. It’s simpler than it sounds and will make more sense once you start trading with actual charts.

Currency pairs are traded in the Forex market. As you know, the Forex market is the most liquid in the financial world. With over $6 trillion traded 24 hours a day, five days a week it is never short of possible currency pairs to trade. The exception of the trading time being bank holidays when the market closes. This huge market allows traders to buy, sell, exchange, and speculate on currencies. It also enables the conversion of currencies for international trade and investment.

There are three categories of currencies:

• The Majors - Major currencies always include the U.S dollar      
• The Minors - (also called Crosses) - The crosses do not include the U.S dollar.
• The Exotics – Consists of one major currency and one currency from an emerging market.

Novice traders do not tend to trade the exotic currencies

So, that’s easy to understand.

Below are the acronyms for the currencies trading in the Forex market

• AUD – Australian dollar
• CAD – Canadian dollar        
• CHF – Swiss Franc
• EUR - Euro
• GBP – British pound
• JPY – Japanese Yen
• NZD – New Zealand dollar
• USD - U.S. dollar

The Major Currency Pairs

The EURUSD is considered to be the most liquid currency pair in the world. The reason is that it is the most traded. It is often a good currency pair for a beginner to work with for their initial education with live trading. The USDJPY is the second most popular currency pair in the world. The Japanese Yen can be a volatile currency which many experienced traders enjoy trading.

All the major currency pairs have the most liquidity, trading 24 hours every business day. The major currencies tend to have smaller spreads, so are a good option for novice traders.

Major Currency Pairs

• EURUSD – Euro / Dollar
• USDJPY – Dollar / Japanese Yen
• GBPUSD – Pound / Dollar
• AUDUSD – Australian dollar / US dollar
• USDCAD – US dollar / Canadian dollar
• NZDUSD – New Zealand dollar / US dollar
• USDCHF – US dollar / Swiss Franc

Minor Currency Pairs (Crosses)

Currency pairs not associated with the U.S. dollar are classified as minor currencies or crosses. They tend to have wider spreads and liquidity may not be as good as the major currency pairs. That said, don’t let this put you off. They are still liquid enough markets for trading.

Along with the major currency pairs, the below list is the currency crosses you will see in most broker accounts -

Euro Cross Pairs

• EURCAD
• EURCHF
• EURGBP
• EURJPY
• EURNZD
• EURUSD

Japanese Cross Pairs

• AUDJPY
• CADJPY
• CHFJPY
• EURJPY
• GBPJPY
• NZDJPY

British Pound Cross Pairs

• EURGBP
• GBPAUD
• GBPCAD
• GBPCHF
• GBPJPY
• GBPNZD

Australian Dollar Cross Currency Pairs

• AUDCAD
• AUDJPY
• AUDNZD
• AUDCHF
• EURAUD
• GBPAUD

Canadian Dollar Cross Currency Pairs

• AUDCAD
• CADCHF
• CADJPY
• EURCAD
• GBPCAD
• NZDCAD

New Zealand Dollar Cross Currency Pairs

• AUDNZD
• EURNZD
• GBPNZD
• NZDCAD
• NZDCHF
• NZDJPY

Swiss Franc Cross Currency Pairs

• AUDCHF
• CADCHF
• CHFJPY
• EURCHF
• GBPCHF
• NZDCHF

Exotic Currency Pairs

As a Forex trader, you are unlikely to trade the exotic pairs but it’s worth knowing what they are.

These pairs aren’t traded as much as the major or minor currency pairs. They tend to have low liquidity. What this means, of course, is the spreads are usually bigger. You could expect to see spreads two to three times bigger than say EURUSD.

Due to the low liquidity, exotic pairs tend to be reactive to economic and political news. Scandal or unexpected election results can create huge volatility in these currency pairs.

Below is a list of the exotic pairs :

• USDBRL  ~  United States / Brazil
• USDHKD ~  United States / Hong Kong
• USDSAR ~  United States / Saudi Arabia
• USDSGD ~ United States / Singapore
• USDZAR ~  United States / South Africa
• USDTHB ~  United States / Thailand
• USDMXN ~ United States / Mexico
• USDRUB ~ United States / Russia
• USDPLN ~  United States / Poland
• USDCLP ~ United States / Chile

Conclusion

Once you start trading currency pairs, you will find which ones are your favourites. The majors are always a good place to start. But the crosses can be lucrative. Once you understand the currency pairs price action, and what they tend to react to, it becomes easier to trade. Some pairs aren’t stirred by news events. Other pairs can make huge moves in the market after a news announcement. You can learn more about economic news here.

In the next guide section, you will learn fundamental analysis, what it is and how you can practice it.

Next: Understanding Fundamental Analysis