Foreign exchange (forex) trading is a popular investment opportunity and involves the trading of currency pairs. But what exactly is a currency pair, and how does it work?
In this guide, we’ll explain everything you need to know about currency pairs, how they function, and which pairs are the most commonly traded so that you can make informed trading decisions.
Read on to start learning!
What Is the Forex Market?
The forex market (FX), short for “foreign exchange market,” is a global marketplace where currencies are bought, sold, and traded. It’s the largest and most liquid financial market in the world, with a daily trading volume exceeding $6 trillion. This immense volume is driven by a variety of participants, including banks, corporations, governments, and individual traders.
Unlike traditional stock markets, the forex market operates 24 hours a day, five days a week, across different time zones. It opens in Sydney and moves to Tokyo, then London, and finally New York, which allows for continuous trading opportunities. This round-the-clock operation is due to the decentralized nature of forex trading, which takes place over-the-counter (OTC) rather than through a central exchange.
The main purpose of the forex market is to facilitate international trade and investment. For example, if a U.K. company wants to import goods from Japan, it must exchange British Pounds (GBP) for Japanese Yen (JPY).
However, people wanting to participate in forex themselves tend to turn to trusted forex trading platforms many traders seek a forex trading platform with frequent payouts with the hope of profiting from fluctuations in currency values.
What Is Currency Trading (Forex)?
Currency trading, also known as forex trading, involves buying one currency while simultaneously selling another. Currencies are always traded in pairs, known as currency pairs, because you are exchanging the value of one currency against another.
For example, if you believe the value of the euro (EUR) will rise against the U.S. dollar (USD), you would buy the EUR/USD currency pair. If the euro’s value does increase, you can sell the pair at a higher price, making a profit. Conversely, if the euro declines, you would incur a loss.
Forex trading is influenced by several factors, including:
- Economic data (e.g., employment reports, GDP figures)
- Political events (e.g., elections, trade agreements)
- Market sentiment and speculation
- Interest rate changes by central banks
Therefore, successful forex trading requires a good understanding of all these factors, as well as effective risk management and trading strategies to avoid financial loss.
What Is a Currency Pair?
A currency pair is a quotation of two different currencies, showing the value of one currency relative to the other. In forex trading, currencies are always quoted in pairs because you are comparing the value of one currency against another.
Each currency pair consists of:
- Base Currency: The first currency listed in the pair. It’s the currency you are buying or selling.
- Quote Currency: The second currency listed in the pair. It’s the currency against which the base currency is valued.
For example, in the currency pair EUR/USD:
- EUR (Euro) is the base currency.
- USD (U.S. Dollar) is the quote currency.
If the EUR/USD exchange rate is 1.20, it means that one euro is worth 1.20 U.S. dollars. If this rate increases to 1.25, the euro has strengthened against the dollar. Conversely, if it drops to 1.15, the euro has weakened.
How Does a Currency Pair Work?
Currency pairs show how much of the quote currency is needed to buy one unit of the base currency. In other words, it represents the exchange rate between the two currencies.
For example, if the GBP/USD exchange rate is 1.30, it means that one British Pound (GBP) is worth 1.30 U.S. Dollars (USD). If you believe the pound will strengthen against the dollar, you can buy the GBP/USD pair. If the exchange rate rises to 1.35, you can sell the pair at a higher price, making a profit.
There are two prices quoted for every currency pair:
- Bid Price (The price at which you can sell the base currency)
- Ask Price (The price at which you can buy the base currency)
The difference between the bid and ask price is known as the spread, which represents the cost of trading. Spreads can vary depending on market conditions, liquidity, and the currency pair being traded.
Currency pairs are also categorized into three types:
| Currency Pair Category | Explanation |
| Major Pairs | Include the most traded currencies globally, such as EUR/USD, GBP/USD, and USD/JPY. |
| Minor Pairs | Do not include the U.S. dollar but involve other major currencies, like EUR/GBP or GBP/JPY. |
| Exotic Pairs | Consists of one major currency and one emerging market currency, such as USD/TRY (U.S. Dollar/Turkish Lira). |
Exchange Rates Explained
Exchange rates determine the value of one currency relative to another. It’s important to note that these rates fluctuate constantly due to supply and demand dynamics in the forex market.
Some factors that can impact exchange rates include:
- Interest Rates – Higher interest rates attract investors seeking better returns, increasing demand for that currency.
- Economic Indicators – Reports on inflation, employment, and GDP impact a country’s currency value.
- Political Stability – Countries with stable political environments attract foreign investment, strengthening their currency.
- Market Sentiment – Traders’ perceptions and expectations influence buying and selling decisions, affecting exchange rates.
Exchange rates are typically quoted to four decimal places, except for currency pairs involving the Japanese Yen (JPY), which are quoted to two decimal places.
What Are Common Currency Pairs?
Some currency pairs are more popular and widely traded than others due to being liquid currencies that are considered more stable. The most common currency pairs, known as major pairs, include:
- EUR/USD (Euro/U.S. Dollar) – The most traded currency pair in the world.
- GBP/USD (British Pound/U.S. Dollar) – Also known as “Cable.”
- USD/JPY (U.S. Dollar/Japanese Yen) – Popular due to low spreads and high liquidity.
- USD/CHF (U.S. Dollar/Swiss Franc) – Viewed as a safe-haven currency pair.
- AUD/USD (Australian Dollar/U.S. Dollar) – Influenced by commodity prices.
Knowledge is Key to Successful Trading
Currency pairs are the foundation of forex trading and allow traders to profit from changes in exchange rates. For smart investing, it’s important to understand how currency, exchange rates, and currency pairs work, along with the factors influencing exchange rates to make wise and sound investment choices.
Though you’ve learned a lot of the basics about currency pairs in forex exchanges through this article, learning is a continuous process. We advise you to keep reading to broaden your knowledge. Happy investing!