The value of one currency is compared to the value of another currency using a currency pair. The base currency (also known as the first currency) is compared to the quote currency (also known as the second currency).
This number reflects the amount of the quote currency that must be paid in order to purchase one unit of the base currency.
In this article, we explore the different types of currency pairs and discuss why currencies are traded in pairs in Forex.
Understanding currency pairs
The value of one currency is measured in relation to that of another through the use of currency pairs, which are found on the foreign exchange market. The first currency in the pair is referred to as the ‘base’ currency, while the second currency in the pair is referred to as the ‘quote’ currency.
Together, these two currencies make up the currency pair. The amount of the quote currency that must be paid in order to acquire one unit of the base currency is reflected in the price that is presented.
The foreign exchange market is also known as the currency market or the forex (FX) market. It is the largest and most liquid financial market in the world, with daily trading volume of over $5 trillion worth of currencies.
Trading in foreign exchange always takes place in pairs. This is due to the fact that foreign exchange trading involves buying one currency while concurrently selling another. One can consider the currency pair itself to be a single unit, an instrument that is either purchased or sold at a given point in time.
The Euro and the US Dollar (EUR/USD) and the British Pound and the Japanese Yen (GBP/JPY) are two examples of currency pairs.
Understanding currency correlation
The term “correlation” is used to refer to the similarities that are shared by different currency pairings. On the foreign exchange market, no currency pair is ever exchanged in a manner that is wholly detached from the trading of the other currency pairs.
When it comes to portfolio management, having a working knowledge of forex correlation pairs is helpful. A trader is said to be trading a derivative of the euro dollar (EUR/USD) and dollar yen (USD/JPY) pairs when they trade the euro against the Japanese yen (EUR/JPY pair), for instance.
Because of this, the EUR/JPY pair must have some kind of correlation with either one of these other currency pairs, or both of them.
It is helpful to obtain a better grasp of the correlations between different currencies and gain some insight into the relationship between different currency pairs.
It may be helpful to consider if they are positively correlated or negatively associated, or whether they are likely to move in the same direction, opposing directions, or completely randomly. When engaging in transactions involving currency pairs, all of these factors are essential to keep in mind.
Major currency pairs
When placing an order in the foreign exchange market, traders have a wide selection of currency pairs from which to choose.
All currency pairs that include the US dollar (USD), the currency of the nation with the largest economy in the world at the present time, are considered to be major currency pairs. On the foreign exchange market, the major currency pairs are the ones that see the largest volume of trade.
Seventy-five percent of all currency trading is done in the major pairs. They account for the overwhelming majority of all currency trades. These currency pairs have the highest volume of buyers and sellers, and as a result, their bid and ask spreads are often the narrowest.
The difference between the buy price and the sell price is referred to as the spread. The majority of traders would probably agree that trading any of the seven major currency pairs listed above can result in the highest profits.
The following is a list of the seven major currency pairs that are considered to be the most popular across the world. CFDs can be used to trade on each of these currency pairs with brokers like Khwezi Trade:
Minor Currency Pairs
Cross-currency pairs, also known as minor currency pairs, are currency combinations that do not include the US Dollar as one of the currencies.
In the past, if traders wanted to change one currency into another, they first had to convert the original money into US dollars, and then they could convert those dollars into the currency of their choice.
Because currency crosses are now available, traders with brokers like Khwezi Trade no longer have to perform these laborious calculations; instead, they can take use of the fact that all brokers now give immediate prices.
The three most important currencies that are not the US dollar are the source of the majority of the most active crosses (the Euro, the UK Pound and Yen). Minor currency pairs are those that are not widely traded.
Popular minors which traders can access through brokers like Khwezi Trade include the following:
Exotic currency pairs
A major currency is paired with the currency of an emerging or a strong but smaller economy from a global perspective.
Examples of such economies include Hong Kong and Singapore, as well as European countries that are not members of the Euro Zone. Exotic currency pairs are comprised of both of these currencies.
Because these currency pairs are not traded as frequently as the majors or the minors, the cost of trading these pairs can often be greater than the cost of trading the majors or the minors because there is less liquidity in these markets.
Some more popular exotic which can be trade include the following:
Market movements that affect currency pairs
The value of one currency relative to another is one factor that might cause fluctuations in the exchange rate.
Traders are constantly on the lookout for favourable exchange rates. These rates are provided by banks all around the world and are updated in time periods of less than one second; the foreign exchange market moves at an exceedingly rapid pace.
The prices of currency pairs can also be influenced by the pricing of commodities. Commodity currencies are ones that are used in countries that are rich in various commodities or other natural resources and produce their own currency.
The level of export activity in each of these countries has a direct influence on the currency exchange rates in those countries.
This is due to the fact that the value of the country’s natural resources can have a significant impact on the strength of the economy. Russia, Saudi Arabia, and Nigeria are three examples of countries that fit this description.
How to trade currency pairs
To successfully buy and sell currency pairings, follow these steps:
Make a decision on how you want to trade foreign exchange: foreign exchange trading through a broker like Khwezi Trade
Discover how the foreign exchange market operates: Foreign exchange is transacted through a global network of banking institutions. This type of market is referred to as an over-the-counter (OTC) market.
Construct a trading plan: a trading plan can help you remove emotion from your decision-making process and can give some structure for when you start and end positions in your account.
Determine the platform that you will use to trade forex: Personalized alerts, interactive charts, and risk management tools may be added to each of the forex trading platforms, including MT4, so that they are tailored to the individual trading style and preferences of each trader.
Create your first position by deciding whether you will buy or sell, specifying the size of your position, and taking other measures to control the risk associated with your investment.
How to reduce risk when trading currency pairs
Forex risk management refers to the process of implementing a set of rules and procedures to one’s forex trading in order to reduce the likelihood of unfavourable outcomes and maximize profits.
If you have an efficient risk management approach, you will have a better degree of control over the profits and losses associated with your foreign exchange trades. When trading forex, efficiently managing your risk may be accomplished by following these steps:
- Acquire as much knowledge as you can about the foreign exchange market.
- Learn the ins and outs of leverage and derivative products.
- Construct your own individualized trading plan.
- Establish a risk-to-reward proportion.
- Make use of constraints and boundaries to reduce the dangers you face.
- Manage your emotions
- Keep abreast on what’s happening in the world and in the news.
- If you feel you need more time, I recommend beginning with a demo account.
Exchanging one currency for another is a form of speculative trading that seeks to profit on changes in the value of the underlying currency pair. Because all forex transactions include the purchase and sale of one currency for the benefit of another, it is priced in pairs. If you think the base currency is going to strengthen versus the quote currency, you’d purchase the pair.