While you go about your daily lives, trading and transactions worth billions and billions of dollars take place each day. You might have come across the term Forex at least a few times and must have wondered what it entails.
Just like the Stock Exchange Market, where stockbrokers and traders facilitate the buying, selling, and trading of various financial instruments like shares, bonds, stocks, etc., Foreign Exchange Market deals with the trading of currencies.
The Foreign Exchange market, simply referred to as Forex (FX), is a global over-the-counter marketplace that trades in currencies. It is one of the biggest markets, with trillions of transactions taking place around the clock. It is a decentralized market where traders, institutions, and even individuals can buy or sell currencies.
Forex trading entails trading one currency for another, i.e., one is always selling a currency while acquiring another. Since this takes place simultaneously, the currency is traded in pairs.
This is known as Currency Pairs, where two currencies are grouped for trading.
What are Currency Pairs?
A currency pair is a pair of two national currencies of different countries that have been paired together for facilitating trade in the Forex market. These currencies have exchange rates, which are nothing but values each currency possesses determined by the market.
A currency pair denotes one currency versus another, for they are always quoted instead of or to the other currency. For e.g., EUR/USD is a currency pair that denotes the value of the Euro as opposed to the US dollar. In this, one of them is bound to be stronger or weaker than the other. Depending on which currency is stronger at a given moment, the exchange rates fluctuate.
Forex trades at least 50 currency pairs in its market. However, not every pair is as widely traded as the other.
Three major types of currency pairs can be found during trading.
Types of Currency Pairs
Since trading within Forex takes place using currency pairs, one can find three major groups of currency pairs. These are:
Major Currency Pairs
These are the most commonly traded currency pair in the world. These contain the U.S dollar (USD) on one side instead of the currency of other prominent countries. They are generally referred to as “Majors,” and their prices tend to move more frequently than the other two types.
They are usually profitable and make for a good trading opportunity. They are considered the most “Liquid,” which means that these currency pairs are traded widely in large volumes by the market’s active traders. The more a currency pair is traded, the more liquid it is considered to be. The following is a table containing some widely traded Major Currency Pairs:
| CURRENCY PAIRS | COUNTRIES | COMMONLY REFERRED AS |
| EUR/USD | Eurozone/United States | Eurodollar |
| USD/JPY | The United States/Japan | Dollar Yen |
| GBP/USD | United Kingdom/ United States | Pound Dollar/Cable |
| USD/CAD | The United States/Canada | Dollar Loonie |
| AUD/USD | Australia/United States | Aussie Dollar |
| USD/CHF | The United States/Switzerland | Dollar Swissy |
| NZD/USD | New Zealand/United States | Kiwi Dollar |
Minor/ Cross Currency Pairs
The currency pairs which do not entail the U.S dollar are referred to as Cross Currency pairs or more generally as “Minors.” Though not as largely traded as the Major currency pairs, these pairs are still considered to be liquid. These can also be used for trading as they are also rich with trading opportunities.
The most actively used cross currency pairs are derived by pairing the following three big non-USD currencies with other currencies:
- EUR
- JPY
- GBP
Exotic Currency Pairs
These currency pairs are obtained when a powerful and major currency of a country is paired up with an emerging economy’s currency. Examples of such emerging economies are Brazil, Chile, Mexico, Hungary, etc.
Since these exotic currency pairs aren’t as popular as the Major and Minor currency pairs, trading them can be costly as your trader might charge you with a higher transaction cost. They are also always at a higher risk than the other two to get affected by economic and geopolitical events. Hence, you should always keep their sensitive nature in mind, along with its low liquidity property.
A few examples of these Exotic Currency Pairs can be seen in the table given below:
| CURRENCY PAIR | COUNTRIES | COMMONLY REFERRED AS |
| USD/BRL | United States/Brazil | Dollar Real |
| USD/SGD | The United States/Singapore | Dollar Sing |
| USD/ZAR | The United States/South Africa | Dollar Rand |
| USD/THB | The United States/Thailand | Dollar Baht |
The Basics of Currency Trading
With money on the line, while trading in Forex, it is incumbent to properly understand the basic nuances of how the trading takes place. Forex entails trading of one currency with another. Therefore trading is always done with currency pairs.
Forex operates 24 hours a day, five days a week, in three main sessions, usually overlapping. Each currency pair is quoted in pips, which are known as “Percentage In Point” till four decimal points. For e.g., if EUR/USD is quoted as 1.1315, this means that one Euro is valued at 1.1315 times of a US dollar.
Currencies are traded in what is commonly termed as “Lots.” One micro-lot is 1,000 units of one currency. While one micro-lot is 10,000 units of a currency, the standard-lot is 100,000 units. Therefore, new traders usually dabble with micro and mini lots as it is much better to incur small losses than bigger ones. Therefore, you should always start by trading in smaller lots unless you are sure about how the value of the currencies will swing.
Currencies and their values are highly volatile as a lot of factors like economic, political, etc. policies and events can increase or decrease it. Therefore, before buying or selling currency pairs, you should always research the currencies, their countries, the supply and demand trend, as well as historical and current market trends, to analyze which will be profitable for you.
If you are a trader, or simply someone who wishes to enter into the intriguing world of Foreign Exchange, then you should be mindful of how to buy and sell currency pairs. Let’s assume that you wish to buy the EUR/USD. Here, EUR is the base currency, while USD is the Quote or Term currency.
You should buy currency only when you believe that the value of the base currency, i.e., EUR in this case, will increase as compared to the USD. Only when you believe that the price of the Euro will appreciate as opposed to the dollar should you buy the Euro, which is said to be “Bullish.” While the USD is said to be “Bearish” here in this instance.
Similarly, when you anticipate the value of the base currency to fall as opposed to the quote or term currency, then you should sell the base currency. Therefore, say the value of EUR is to depreciate as compared to USD, you should sell the “bearish” EUR. Here, USD will be considered the “bullish” or the stronger currency.
Things to Keep in Mind
The following are some tips that you might want to keep in mind while undertaking your trading:
- You should always start by trading the most commonly and heavily traded currency pairs which fit well according to your budget.
- You should never trade based solely on guess-work and emotions. Your trade should always be founded on solid market analysis and research. Keep yourself abreast of the historical and current market trends, the economic news as well as keep an eye out on the current market scene. This will help you make informed decisions about which currency to buy and which currency to sell.
- Your aim should always be to increase profit and cut losses as much as you can. You need to prepare well in advance to minimize the risks. This takes a lot of learning and practice. So, be patient with your investments and tradings.
Summing Up
The Forex market is one of the biggest markets in the word which dabbles in trillions of dollars every single day. With so many factors affecting the market and the value of currencies, it is important to keep yourself updated with the latest market trends and news.
The trading in Forex can be done with a varied combination of currency pairs. However, few currency pairs have leverage over the others for being widely used and traded. Currency pairs should always be chosen, keeping in mind their value, liquidity, and transaction costs. The more liquid and powerful a currency pair, the better investment it is.
You can get a better understanding of buying and selling currency pairs by opening up an account on IC Markets or XTB.