Forex Trading: Understanding Currency Pairs
In Forex trading, the two currencies being traded make up a currency pair, and there are many different pairs that Forex day traders can trade. Traders can choose "major pairs," "crosses," and "exotics," and there are pairs that are common like EUR/USD (euros and U.S. dollars) and much less common like USD/MXN (U.S. dollars and Mexican pesos).
For starters, though, let's take a look at what a currency pair consists of. Currency pairs are made up of a base currency (the first) and a counter currency (the second). In the EUR/USD currency pair, EUR is the base currency and USD is the counter currency. If the exchange rate of a pair is rising, the base currency is rising in value relative to the counter currency. When the exchange rate falls, the opposite is happening.
Additionally, when we look at exchange rates, the rate is the amount of the counter currency needed to buy 1 of the base currency. For example, if GBP/USD is priced at 1.5000, it would take 1.5 U.S. dollars to buy 1 British pound.
What are the Major Currency Pairs?
It's widely assumed that there are four major currency pairs, although some say there are 6 or 7 "majors." These four pairs drive the most action in the Forex market, and they are the most heavily traded. That means there is tons of trade volume and liquidity in each of these pairs, and therefore, the behavior of these pairs is more predictable.
The four major pairs include:
"Euro" - EUR/USD (euros and U.S. dollars)
"Cable" - GBP/USD (British pounds and U.S. dollars)
"Gopher" - USD/JPY (U.S. dollars and Japanese yen)
"Swissie" - USD/CHF (U.S. dollars and Swish francs)
Of these four, the "Euro" tends to be the most popular trading pair. The reason: The U.S. and European Union are the two largest economies in the world, they are the most widely held currencies, and this pair is the most widely traded. Yet, all four feature massive volume and they are all heavily traded.
In general, many of the major currencies make similar movements in the markets. For example, EUR/USD and GBP/USD tend to move in a similar direction; if one is falling, the other will likely be falling. That's not always true, but it happens quite frequently. Thusly, a trader would likely not hold similar position in these currency pairs, as it would double up their risk. USD/CHF, though, has a negative correlation with GBP/USD and EUR/USD; that means as EUR/USD rises, USD/CHF falls and vice versa. These are not rules, but generalities. So they may not apply in all circumstances.
Additionally, several commodity currencies including the Australian, New Zealand and Canadian dollar may also be considered major currency pairs. These pairs are AUD/USD, NZD/USD, and USD/CAD. Gold and silver are also commodities and are paired with the U.S. dollar: XAG/USD and XAU/USD.
Crosses and Exotics: Other Types of Currency Pairs
Traders may want to diversify their trades and move away from the major currency pairs. Crosses and exotics offer that opportunity. Crosses are currency pairs in which neither currency is the U.S. dollar, and there are several benefits to trading crosses.
First, traders can avoid speculating on the movement of the USD. This strategy might be useful if major U.S. economic news is expected like a jobs report or interest rate changes, both of which can create volatility in the market. Additionally, the crosses tend to have stronger trends due to diverging interest rate expectations and other economic factors. This enables more accurate trend trading.
