What are Forex Currency Pairs and how do they work?
You’re somewhere mid-air over the Atlantic, flying to New York for a lavish city break. Mad to imagine in pandemic-ridden 2020, but let's run with it. As soon as the plane's wheels hit the tarmac at JFK airport, it dawns on you—you've forgotten to bring any US dollars along. Not to worry. You head through passport control and make a beeline for the airport’s exchange bureau. You hand €100 in banknotes to the cashier who gives you $120 in return based on that day’s exchange rate, and off you trot to enjoy the best of the Big Apple.
Thanks to the miracle of credit cards and digital wallets, you end up not spending any physical cash during your New York trip. So you now need to convert your dollars back into euros before flying home. Fortunately, in the interim, the US dollar has strengthened against the Euro, meaning that when the cashier hands you back your money, you’re €5 up from your initial deposit. A neat little profit for just storing some banknotes in your wallet for a week.
If you’re familiar with a version of the above scenario, then you’re already halfway to understanding Forex and the trading of currency pairs. In this article, we’ll look deeper into the Forex market, various combinations of currency pairs, and explain how Forex trading works.
What is Forex?
The Foreign Exchange market (or Forex) is a decentralised marketplace where national currencies are traded. Officially the world's most liquid market, Forex sees an average global daily turnover of over $5 trillion. The market has no centralized location and consists of an electronic network of banks, brokers, institutions, and individual traders who typically trade through online broker platforms such as Longhorn FX from the comfort of home.
Unlike other trading markets which are tied to strict office hours, Forex is tradable on a 24-hour basis, five days a week. Trading is commonly split into four major sessions—the Sydney session, the Tokyo session, the London session, and the New York session—and various unfolding political, economic, and social events have a direct impact on how price movements between different currency pairs fluctuate.
So, how does Forex Trading work?
Trading Forex: Currency Pairs explained
The first rule in Forex trading is that currencies are always traded in pairs. As the name suggests, a currency pair quotes two different currencies together and indicates their value in relation to one another. Each currency is designated a three-letter code, called an ISO currency code, which makes it instantly identifiable to traders around the world. For example, the most common currency pair is the EUR/USD, with EUR representing the Euro and USD the US Dollar. The currency that is listed first is called the base currency. The second is the quote currency.
In Forex, trades always happen in pairs, meaning that if you are buying a currency, you are automatically selling another, or vice versa. A currency pair indicates how much of the quote currency a trader will get in exchange for buying a single unit of the base currency. In EUR/USD, for example, the ‘Bid’ price indicates the amount of USD you will get for selling 1 EUR, while the ‘Ask’ price indicated how many EUR you can buy for 1 USD.
With 154 currencies in circulation around the globe, there are numerous currency pairs available to trade on. It can all get a tad overwhelming. Thankfully, there are plenty of popular currency pairs to look out for, which are considered ideal for those new to Forex to start trading on. So, let’s explore some.
Major Currency Pairs
Different traders and brokers may offer variant lists of major currency pairs depending on where they are based. Typically, majors cover currencies that trade the most volume against the US dollar. The big four include EUR/USD, GBP/USD, USD/CHF, and USD/JPY.
The EUR/USD, sometimes referred to as ‘Fiber’, is the most traded currency pair. This makes sense given that the United States and the European Union boast the strongest economies in the world.
Commodity currencies are also commonly classified as majors. These include the AUD/USD, NZD/USD, and USD/CAD. As these countries are rich in commodities like oil, timber, beef, wool, and wheat, their economies are greatly influenced by the prices of these commodities.
Minors & Exotics
Currency pairs that do not include the US dollar are typically referred to as minors or crosses. These pairs are not as liquid as the majors. Nevertheless, some are still considerably large markets with a significant volume of trades occurring on a daily basis.
The most popular cross pairs are those that include at least one of the other individual currencies within a major, e.g. EUR/GBP, GBP/JPY, and EUR/CHF. The countries within these pairs usually enjoy strong political or economic relationships, meaning they are relatively stable markets. For example, despite all the recent brouhaha surrounding Brexit, the UK and European Union have historically enjoyed strong economic ties.
Exotics, on the other hand, include currencies of emerging markets such as the Singapore dollar (SGD) or Turkish lira (TRY). These currency pairs are not as liquid as the majors and often experience more volatile market conditions, making them more unpredictable markets to trade in.
How to Trade Currency Pairs in Forex
The aim of Forex trading is to make a profit by speculating on whether the value of one currency will rise or fall in relation to the other currency within a pair.
If a trader believes prices are set to rise, they open a buy position and hope to close it for a higher price at a later date. Conversely, if they have an inkling prices will dip, they open a sell position and hope to close it when the prices decrease. The amount of profit a trader will make depends on the difference in price value of the underlying asset between the time they open and close their position.
Skilled Forex traders will use a range of strategies to make educated predictions about the direction of price movements. Some time-tested Forex tips that will serve any trader well are:
- Be mindful of current affairs, global events and financial anomalies that can have a big impact on a currency pair.
- Use an economic calendar to stay ahead of major data releases.
- Take advantage of technical analysis reports that can predict trendlines and price patterns.
- Stay up to date with popular Forex news and analysis sites to be prepared for volatile conditions.
- Assess the risks and never trade more than you can afford to lose
You can trade over 55 currency pairs, including majors, minors, and exotics with 1:500 leverage at Longhorn FX . Benefit from 24/7 support and same-day withdrawals when opening a free account!