About Forex

Foreign Exchange Trading: Currency Pairs

When undertaking forex trading, it is essential for a trader to first understand currency pairs. A currency pair is the method for quoting foreign currencies in comparison to each other. In other words, currency pairs denote the relative value of one currency against another.

The quote currency is the currency that is used as a reference to the base currency. The quote currency is also known as counter currency, and the base currency can also be referred to as the transaction currency.

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Formatting of Currency Pairs

Currency pairs are quoted using the currencies standard abbreviations, with the base first and the quote second. For example, a currency pair having a base currency of the Australian dollar and a counter currency of the United States dollar would be quoted as follows: AUD/USD

This quote tells us that one Australian dollar can be exchanged for 1.0350 USD. If the quote changes from AUD/USD 1.0350 to AUD/USD 1.0360, the Australian dollar has increased in relative value by 10 pips. This increase can be attributed to a weaker purchasing power for the USD or a stronger purchasing power for the AUD, or both. Standard currency abbreviations are determined by the International Organisation for Standardization (ISO).

Hierarchy of Base Currencies

Accepted priorities exist when quoting currency pairs in regard to the base currency. The currency with the higher priority should be listed as the base in a currency pair. For example, since its inception in 1999, the Euro has held first precedence. Therefore, any currency pair quoting the Euro should use it as the base. The generally accepted priority ranking of the top eight currencies is as follows:

  1. Euro (EUR)
  2. Pound Sterling (GBP)
  3. Australian dollar (AUD)
  4. New Zealand dollar (NZD)
  5. United States dollar (USD)
  6. Canadian dollar (CAD)
  7. Swiss franc (CHF)
  8. Japanese yen (JPY)
  9. Classification of Currency Pairs

Majors:

The most traded pairs of currency in the world are known as the Majors. These constitute the largest share of the foreign exchange market at about 85%, and always have the USD as one half of the pair. As of the end of 2012, the most traded currencies by value were as follows:

  1. United States dollar (USD)
  2. Euro (EUR)
  3. Japanese yen (JPY)
  4. Pound Sterling (GBP)
  5. Australian dollar (AUD)
  6. Swiss Franc (CHF)
  7. Canadian dollar (CAD)
  8. Hong Kong dollar (HKD)
  9. New Zealand dollar (NZD)
  10. South Korean won (KRW)
  11. Singapore dollar (SGD)
  12. Norwegian krone (NOK)
  13. Swedish krona (SEK)
  14. Mexican peso (MXN)
  15. Indian rupee (INR)

Minors:

Some define minor currency pairs and crosses similarly, but the minors have historically included USD-based pairs that weren´t part of the top three or four traded currencies. For example, USD/JPY is a major pair, but HKD/USD is not.

Cross:

Currency pairs that do not involve the USD are known as cross rates, or crosses. AUD/NZD is the Australian dollar/New Zealand dollar cross, for instance. Euro crosses describe currency pairs that trade against the Euro, but which would normally partner up with the U.S. dollar. For example, EUR/JPY, EUR/GBP or EUR/AUD.

Exotic:

This refers to currency pairs involving an emerging market currency - e.g., Philippines or Mexico - which is not highly liquid (they tend to have a wide bid/offer spread and usually deal in smaller sizes).

Commodity Currency:

This is a currency whose underlying economy is linked to the importance of resources or agriculture. It can be a developed or an emerging economy - e.g., Australian dollar, Canadian dollar, New Zealand dollar or Brazilian real.

Flight to Safety:

In times of financial market stress, some currencies are bought because they are viewed as a calm port in a storm. The USD and Swiss franc have historically been the currencies that filled this role.