What are currency pairs? If you are just starting out in the Forex market you may have become inundated with jargon. Pips, leverage and spreads may sound complex. Forex is actually one of the easiest investments for a beginner to understand if you purely think of it like this: you are investing in one currency against another. That’s it. These are simply known as currency pairs.
When you invest in a currency pair you are betting that one will do better converting into the other one. Forex always includes two currencies. One is necessary to buy or sell the other, otherwise it wouldn’t be foreign exchange. The common comparison is to think of it like going on holiday and exchanging currencies. The most popular currency pairs are known as major currency pairs. In this guide we will introduce the top currency pairs to you and explain how they work and why or why not they may be a worthy fit for you as you get started.
Basics of all currency pairs
One of the most popular currency pairs is GBP/USD. Let’s say for example that the spread is 1.40466. That means in this pair that one United Kingdom Pound will buy 1.4046 United States Dollars. Learning how to read currency pairs is easy. The first currency (in this case the GBP) is known as the base. The second currency (in this case the USD) is known as the quote, or sometimes called the counter currency. The spread is usually recorded as the fourth decimal position, but sometimes fifth and in the case of the Yen, at the second. This is known as a pip. In this example the pip will be the number six as we see it in the fourth decimal position. If the currency gained to 1.4047, against the USD it would have gained 1 pip. Profits or losses are realised by the number of pips gained or lost.
Major currency pairs explained
There are seven majors from the currency pairs list. They are probably the best fit for a beginning Forex trader due to their liquidity and relative stability. The easiest way to remember these top currency pairs is that all seven contain The United States Dollar (USD) in one of the pairs. It is the most popular and most traded currency in the world. Here’s a list of currency pairs known as majors:
- GBP/USD United Kingdom / United States
- EUR/USD EuroZone / United States
- USD/JPY United States / Japan
- USD/CHF United States / Switzerland
- USD/CAD United States / Canada
- AUD/USD Australia / United States
- NZD/USD New Zealand / United States
Let’s take a look at each one of the best currency pairs in more detail:
GBP/USD is one of the most liquid currency pairs, meaning that the spread is tight. Pounds Sterling have been the most powerful currency in the world for hundreds of years until the USD became the world’s reserve currency in the second half of the twentieth century. When these two countries butt heads economically, generally stronger data from either will propel it over the other in the spread.
Even though it is one of the most popular and consistent currencies pairs in Forex there are always rumors floating around about The United Kingdom joining the Eurozone. There are pros and cons to either decision, which the British Government hashes out regularly. Trading opportunities often exist when this discussion gets heated in Parliament, with a move to the Eurozone to be seen as devaluing the British Pound.
EUR/USD is another popular currency pair that is tightly bound to the economies of the 16 countries of Western Europe that comprise the Eurozone. It is unique on the list of major currency pairs for this reason. Germany and France represent the strongest economies of this young economic experiment that only began in 1999. This unique situation brings an interesting opportunity for the USD to rise relative to the EUR based on problems associated with individual Eurozone countries like Greece or Italy. On the base side of this pair, a fledgling American economy can lead to a relative rise of the EUR.
Interestingly many American companies are headquartered in the Eurozone for the benefit of tax relief, while many Eurozone companies have a powerful economic presence in The United States. This has a puzzling impact on the spread. Either way this is a great currency pair for beginners as it features some of the lowest bid-ask spreads in Forex as well as high levels of liquidity.
USD/JPY is a wonderful currency pair for getting exposure to Asia’s most innovative and hardworking economies. Japan’s resource deficient land mass has excelled at manufacturing and technological innovation since the country’s demise at the end of World War II. Thus, Japan is highly reliant on imports and exports. Although the Yen suffered horribly in the 1980s due to a deflationary trajectory that the country has still not completely recovered from, it is still a safe trade for beginning Forex investors.
Carry trades are a favorite technique for this popular currency pair. It is a trading technique that seeks to sell a low interest rate currency and use the difference to purchase a higher interest rate currency, often with the use of leverage from their broker. The big risk involved in a Yen carry trade is the assumption that the exchange rate will not change. It’s better for beginning traders to keep it simple for now. As an important side note, in JPY based trading, the pip is represented at the second decimal point, instead of fourth.
USD/CHF is a unique currency pair since Switzerland is almost completely surrounded by The Eurozone, yet maintains a completely sovereign economy and currency. Once known as the most neutral country in the world, Switzerland still remains relatively autonomous. Yet the Swiss Bank, known for its financial secrecy allows for one of the best currency pairs with the USD. This main pair offers a wonderful opportunity for the beginning trader as both currencies are often touted as the safe choice during times of global economic fears. Outside of those fears, during times of relative global stability and success, the Swiss Franc correlates well to the Euro.
USD/CAD is a popular currency pair for North Americans. The Canadian Dollar, known as the Loonie is a resource based currency. The greatest impact on this currency pair is the global oil market, accounting for Canada’s’ rich oil sands production in Alberta. As the price per barrel rises or falls so does the Loonie. In addition Canada relies heavily on mineral exploration and processing (both at home and abroad) namely in nickel, copper, and gold. In fact, almost $0.10 of every Canadian dollar is a result of nickel production. Thus the long term spot price for these precious metals can have a long term impact on this top currency pair. The majority of Canada’s exports go across the border to its southern neighbor, so the Loonie can often share a lot of the success or heartache of the USD.
AUD/USD along with the NZD/USD pair is probably the most volatile currency pair for a beginning Forex investor. Australia, like its neighbor New Zealand is geographically isolated from much of the industrial world, requiring more expensive imports and making exports that much more difficult. Nevertheless, Australia, like Canada is a resource rich country with some of the largest holdings of gold, coal, iron and other commodities in the world. The perimeter of the country is complimented with large wheat and beef farms that account for a sizable portion of exports. The Aussie Dollar is often correlated with the price of gold and the smaller population of such an immense country does make it one of the less liquid major currency pairs.
NZD/USD is the last pair in the commodity driven Forex currency pairs. New Zealand is a small island country off the coast of Australia that shares many of the same problems and successes of its neighbor. New Zealand, unlike the resource deficient island of Japan, is a country blessed with mineral resources, livestock, and a relatively open system for trade that is encouraging to other countries. Although this pair is tightly bound to the commodities market, New Zealand has made a concerted effort to ramp up its technology services sector and tourism, which have both grown substantially in the last 20 years.
Understanding currency pairs and their liquidity
Above we looked at the major currency pairs from the perspective of the quote. Let’s take a more general look at the world’s most liquid currency. In general the USD rises and falls compared to other currencies on news of growth or lack of growth from a number sectors or indicators at the national level. Examples including jobless claims might have an impact as well as the manufacturing PMI. Both have a direct impact on the national economy and the United States global output. Overall, the greatest indicator for the potential rise of the USD is a hike in the Federal interest rate. Nevertheless, USD is the world’s reserve currency and is one of the best quote or pairs for a bid or ask.
Other currency pairs
Although majors are the most common currency pairs there are a number of reasons investors may decide to trade outside of these pairs. The most simple reasons not to trade the major pairs is that you have a better understanding or market insight into another currency pair that does not involve the USD. Let’s say for example that you live in the United Kingdom and stay up-to-date on the UK foreign trade with the Brazilian market. You would be more qualified to make a trade in the (GBP/BRL) pair. This is known as a Pound cross. A cross is simply a pair that does not contain the USD. The first currency (known as the bid) takes the name for the cross.
Like so many other investment options, high risk and high reward exist in Forex, often in the form of exotic FX pairs. These pairs involve one major currency like the GBP paired to a currency that is not traded as heavily such as the Swedish Krona (SEK). Just because they are known as exotic pairs does not mean they are necessarily from beautiful tropical countries! These pairs are traded less frequently, therefore there is often less research available and some brokers may not make the trade available in an exotic pair. Even if they do, one has to be careful in using leverage with these pairs, since unlike stocks, losses can be indefinite.
Unlike the exotic pairs, major currency pairs are constantly covered by the leading financial media. Thus, as a beginning trader you are better informed on how to invest in major currency pairs. Not only that but, the exotic pairs might invite unwanted risk from unstable or totalitarian governments who may manipulate their currency on a whim. Sticking with a highly liquid and in demand currency prevents you from being a victim.
Finally, it is still highly recommended that a beginner Forex trader stick with the major currency pairs. They are often the most reliable currencies in the world and are less likely to have a dramatic change in the spread. In addition, trading currency pairs that frequency enables that stability, whereas exotic pairs which are trading infrequently might have major shifts. If you still want to give exotic pairs a try – best to do it on a demo trading account.
Summing it all up
Remember in the Forex market, no matter what FX currency pairs you are trading, you are hedging a bet on one currency over another. When you place your investment, you are using one currency to obtain another at the spread rate. It’s the same action we take every time we go on a holiday and have to exchange money with our bank.
In this case, we can do it all at the comfort of our home computer with a much more friendly spread. In addition, the Forex market is tightly regulated by the FCA here in the UK and the CFTC/NFA in the United States. Plus we have the best Forex books, research, and dedicated broker to allow us to make some safe investments in some of the major currency pairs and maybe a few more volatile investments with the exotic or cross currency pairs.
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