1.4 Trading Currency Pairs

Additional Reading About Trading Currency Pairs

There are many official currency pairs used all over the world, but only a handful are traded actively in the Forex market. In Forex trading, only the most economically or politically stable and liquid currencies are demanded in sufficient quantities. The American dollar is the world's most actively traded currency because of its strength and size.

The eight most traded currency pairs today are the U.S. dollar (USD), the Canadian dollar (CAD), the Euro (EUR), the British pound (GBP), the Swiss franc (CHF), the New Zealand dollar (NZD), the Australian dollar (AUD) and the Japanese yen (JPY).

Mathematically, there are 27 different currency pairs that can be derived from those eight currencies alone. However, there are about 18 currency pairs that are conventionally quoted by Forex market makers as a result of their overall liquidity. The total amount of currency trading involving these 18 pairs represents the majority of the trading volume in the FX market.

More Reasons to Trade Forex - Text Version

How do Currency Pairs Work?

What actually takes place when you are trading currency pairs on the Forex market?
Just like trading stock involves the buying and selling of a piece of a company, Forex trading involves buying a portion of a country’s currency.  The price of the currency is a direct reflection of what the market thinks about the current and future health of the economy of that particular country compared to other countries' economies.

By buying a British pound, for example, you are really buying a share in England’s economy. When the price of the pound changes in relation to another currency and you have correctly predicted the direction, you have made a profit.  If you buy a soccer ball in London and pay 10 GBPs (British Pounds), using a conversion of $1.00 to 2.5 GBP, you have now paid $4.00 for the soccer ball. If you take it home to Chicago and want to sell it to your neighborhood soccer club and the conversion rate has now changed to $1.00 = 3.00 BP, your ball has lost .50 GBP’s per dollar and the $4.00 you thought you spent on the ball is now really only $3.33. Your soccer ball has lost value and if you want to make a profit on your sale, you need to pump up the asking price.  

The symbols used with currency pairs are always listed as three letters, where the first two letters identify the name of the country and the third letter identifies the name of that country's currency. USD stands for United States dollars. NZD stands for New Zealand dollar.

Currency Pairs List

The major currencies in the currency pair lists are: EUR/USD, USD/JPY, GBP/USD, USD/CHF which involve the euro, US dollar, Japanese yen, pound sterling, Australian dollar, Canadian dollar, and the Swiss franc. Those currency pairs that are not paired vs. the U.S. dollar are called “crosses.” Some examples of crosses are:

AUD/NZD – Aussie dollar vs. the New Zealand dollar
EUR/AUD – Euro vs. the Australian dollar
EUR/CAD – Euro vs. the Canadian dollar
GBP/JPY – British pound vs. the Japanese yen

In addition, there are the following two: XAU/USD – Gold
XAG/USD – Silver because gold and silver are actual commodities and can also be considered “commodity currencies.”

These currency pairs are considered by many to drive the global forex market and are the most heavily traded. Some traders also think that the USD/CAD and USD/AUD pairs should also be regarded as major currency pairs. These two pairs can be found in the group of pairs known as the "commodity pairs".

The first currency of a currency pair is referred to as the "base currency" and the second currency is called the "quote currency". The currency pair shows how much of the quote currency is needed to purchase one unit of the base currency.

All Forex trades involve the simultaneous buying of one currency and selling of another, but the currency pair itself can be thought of as a single unit, an instrument that is bought or sold. If you buy a currency pair, you buy the base currency and sell the quote currency. The bid (buy price) represents how much of the quote currency is needed for you to get one unit of the base currency. Conversely, when you sell the currency pair, you sell the base currency and receive the quote currency. The ask (sell price) for the currency pair represents how much you will get in the quote currency for selling one unit of base currency.

Here’s an example: A USD/EUR currency pair is quoted as USD/EUR = 1.5 and you purchase the pair, this means that for every 1.5 Euros that you sell, you purchase (receive) US$1. If you sold the currency pair, you would receive 1.5 Euros for every US$1 you sell. The inverse of the currency quote is EUR/USD, and the corresponding price would be EUR/USD = 0.667, meaning that US$0.667 would buy 1 euro.