Buying and selling foreign currency is the basis of the foreign exchange market. In basic terms, forex means buying or selling a currency in exchange for another currency.
The two currencies together are called a currency pair. There are both major and minor currency pairs, with the US dollar involved in both types of pairs.
What are the most popular currency pairs?
People who trade in currencies refer to the most commonly traded pairs as Majors. These account for around 85% of the foreign exchange market, exhibiting high market liquidity.
A currency pair refers to the quotation of the value of one currency in comparison to another. It is common to refer to the currency used as quote currency or counter currency.
The currency quoted in relation — represented first in the currency pair — is the base currency or the transaction currency. A currency pair essentially shows how much of the quote currency you need to purchase one unit of the base currency.
Accepted global priorities attributed to different currencies have a bearing on the rules that formulate standard currency pair notations. Since its inception in 1999, the European Central Bank stipulates that the Euro take precedence over others as a base currency.
As a result, all currency pairs that include the Euro have to list it first. This is why the EUR/USD currency pair notation denotes the exchange rate between the US dollar and the Euro.
The use of nicknames to refer to popular currency pairs is common. Traders refer to the GBP/USD pairing as cable and to the EUR/USD pairing as Fiber. The EUR/CHF pair takes the nickname “Euro-Swissy” and referring to the USD/CAD pair as “the funds” is also common.
How does a currency pair work?
The exchange rate of a currency pair is subject to change at any given time owing to various factors, which include:
Cause and effect. Even if you trade only in major currencies, know that cross currency pairs can have an effect on your trading. Imagine that the Federal Government announces a rise in interest rates. In such a scenario, the market would typically start buying the US dollar against major currencies. While pairs such as EUR/USD and GBP/USD would fall in value, the value of pairs such as USD/CHF and USD/JPY would yield better dividends.
Appreciation and depreciation. The appreciation or depreciation in the value of any currency has a direct effect on its pairing with other currencies. For example, if you feel the US dollar may depreciate more than the Euro in a given time period, you would stand to benefit by exchanging US dollars for Euros ahead of time. An appreciating currency can lead to cash flow into its country’s assets.
Demand and supply. In the international finance market, if there is a surge in the sale of any particular currency it becomes more easily available. However, if there’s not enough demand for the currency its price will fall in order to strike a new supply and demand balance.
Imports and exports. A currency’s value can have a direct impact on a country’s economy when it comes to international trade involving imports and exports. A general rule of thumb is that a weak currency is good for exports, but makes imports more expensive. Over time, this can decrease a country’s trade deficit.
How do I know when is the right time to exchange my currency pair?
Trading in foreign currency requires that you pay attention to multiple factors. When it comes to exchanging currency pairs, here’s what you need to know:
Economic factors. A host of economic factors can have an effect of currency pairs in the foreign exchange market. These include a rise or fall in a nation’s GDP, a variation in its cash rate, inflation, property bubbles and so on.
Supply and demand of exports and imports. If there’s an increased demand for exports you can expect the currency to underperform in the near future. On the other hand, an increase in imports is a favorable sign for local currencies.
Economic crises. Economic crisis relating to any country or a larger geographical region can have an adverse effect on currency pairs. An example in case is the global financial crisis of 2007 and 2008 that affected various currencies the world over, the US dollar included.
Appreciation and depreciation. If you feel the currency you’re holding onto will appreciate in time, it makes sense to hold on to it. The converse holds true as well.
If you’re new to the world of trading in foreign currencies, it’s in your best interest to learn the ropes first. Know that currency pairs are subject to fluctuations, predicting which can be rather difficult. It is also important that you don’t rely overly on online foreign exchange trading software to do the work for you.
Cross currency pairs refer to currency pairs that don’t involve the US dollar. Examples include AUD/JPY and CAD/RUB. Euro crosses are currency pairs that involve the Euro.
Which are the most traded currencies by value?
The top five include the US dollar, the Euro, the Japanese yen, the Pound sterling, and the Swiss franc.
What are “exotics?”
These refer to pairs that include currencies of emerging and developing economies. Some commonly traded exotic pairs include USD/MXN, USD/BRL, and USD/ZAR.
What are some of the common nicknames of different currencies?
Greenback — nickname for the US dollar
Buck —nickname for the US dollar
Swissie —nickname for the Swiss franc
Aussie —nickname for the Australian dollar
Kiwi — nickname for the New Zealand dollar
Loonie, the little dollar — nicknames for the Canadian dollar
Zak Killermann was a technical publisher at Finder who specialised in currencies and investing. Zak’s expertise was in breaking down technical finance concepts into approachable, digestible nuggets of information.
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