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In forex trading, you are simultaneously exchanging one currency for another. That is the nature of the market. Very simply, a currency pair is two currencies that are “paired” together with the value of one currency expressed in the other.
Through this article we will delve into the exact elements of a currency pair, what the numbers means, and the different types of currency pairs you will undoubtedly encounter when you are trading on the forex market. This should arm you with a good understanding of the different currency pairs available, and also which you may want to trade.
Basics of a Currency Pair
As mentioned, a forex trade is the exchange of two currencies at the same time. What a currency pair does though in the most basic of functions, is to combine this trade of two currencies into one instrument or asset. Let’s take a closer look at how this happens:
The two elements required to make up a currency pair are a base currency, and a quote currency. The base currency is the first abbreviated currency name that you will see, and the quote currency is the second.
For example, if we take the currency pair EUR/USD, then the Euro is the base currency, and the US Dollar is the quote currency. Similarly if we take another example of USD/CAD, the US Dollar is the base currency, while the Canadian Dollar is the quote currency. This is an important first point of reference in helping your understand currency pairs.
The number you then see represents how much of a quote currency it takes to purchase one unit of the base currency. Expanding our example and using today’s rate, if we see EUR/USD = 1.12 then we know that it will cost $1.12 (quote currency), to buy €1 (base currency). Similarly USD/CAD = 1.35 shows us that it costs $1.35 CAD to purchase $1 USD.
So, in the examples set out above, you can see just how two currencies are combined and ready for trading through a currency pair.
Different Types of Currency Pairs
If you start to trade with any forex broker, you will commonly hear three key terms, or categories, when it comes to currency pairs. These are major pairs, minor (or cross) pairs, and exotic pairs. Here is a more detailed look at each category of currency pair.
Major Currency Pairs
There are a total of seven currency pairs that are considered to be major pairs. These all include the US Dollar on one side and are, the EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, AUD/USD, and NZD/USD.
These pairs represent not only most major currencies and economies in the world, but they are also the most traded currency pairs on the market. This means they move more often, though perhaps not as sharply as other currency pairs, and there are usually many opportunities to get involved in trading these pairs at any time throughout the day. Due to the higher volume of these currency pairs traded, the costs like the forex spread can also be lower.
Minor Currency Pairs
Minor currency pairs are those which do not feature the US Dollar on one side of the pair, but that typically do feature one of the other major currencies such as EUR, GBP, or JPY on one side of the pair.
These currency pairs can also be known as crosses, or cross currency pairs. While they are not as widely traded as the major pairs, the top brokers typically stilly carry a large selection of minor pairs that are still quite frequently traded throughout the day. Some examples of popular minor currencies include the EUR/GBP, AUD/JPY, and GBP/CAD.
These minor currency pairs may be slightly more volatile than a major currency pair, and the trading cost in terms of forex spread can certainly be a little higher. With that said though, they are still a well-traded and popular choice for the majority of forex traders.
Exotic Currency Pairs
The third category of currency pairs that you will see on offer are exotic pairs. These pairs are typically made up of one major currency paired with one currency from an emerging economy. Examples here may include USD/RUB, USD/PLN, USD/HKD, and many others.
This type of exotic currency pair will not always be available for trading, though some brokers may carry a selection of them. These pairs are generally traded quite a bit less than the major or minor pairs. This can mean that the spread is much higher in some cases. These pairs can also be significantly more volatile than the other types of currency pairs so this is also something to keep in mind when trading.
Which Currency Pairs Should You Trade?
When you are considering trading, this is a choice that you may have to make depending on which currency pairs your broker decides to offer. Ultimately, the choice is up to you, though there are a couple of key points to note when you are trading in each different category of currency pairs.
The first of those is trading cost. As mentioned, you will find that the trading cost of a major currency pair is generally much lower than that of an exotic pair, and slightly lower than a minor pair. If this cost is a concern then be sure to factor it into your trading, and always double check the spreads before you place your trade. As a point of interest, the EUR/USD pair is most frequently traded currency pair on the market and often offering the lowest spread depending on your broker.
The second consideration you should make is to think of market volatility. Typically, the lesser traded currency pairs, and in particular exotic currencies can suffer from sudden and sharp swings. This is in part due to the lower volumes traded, but also in part due to the sensitivity of currencies in emerging markets when it comes to social and political issues.
Anthony is a financial journalist and business advisor with several years’ experience writing for some of the most well-known sites in the Forex world. A keen trader turned industry writer, he is currently based in Shanghai with a finger on the pulse of Asia’s biggest markets.