What is a Currency Pair?
Trading the foreign exchange market means trading currency pairs so this is the very first notion one needs to understand before even considering trading. The purpose of this article is to make you familiar with what a currency pair is and the logic behind pairing different currencies together, as well as to present the factors that make a currency pair move and how a profit can be made. The overall forex market is organized in currency pairs that are fluctuating 24/5 with Saturday and Sunday market being closed. This is just a matter or saying as many times during the weekend important events, either political or economic are happening and at the opening on Monday currencies will have gaps and in reality, it means that this market is monitored 24/7 as currency pairs move on very little. Having said that, currencies are paired with one another on the basis of their importance and taking into account the US dollar, the world’s reserve currency.
Currency Pairs Classification
The first differentiation that is being made is between major currency pairs and crosses. A major is a currency pair that has the US dollar in its componence, and the main representatives here are the EUR/USD, GBP/USD, USD/JPY, USD/CHF, AUD/USD, etc. Following the same logic, a cross is a currency pair that doesn’t have the US dollar in its componence. Using the currency pairs listed above, examples of crosses are EUR/AUD, GBP/JPY, EUR/JPY, GBP/AUD, etc. This way currencies are paired with the US dollar and against other currencies as well. This classification is extremely important as it shows the way the market is organized and the importance of these currency pairs. As a rule of thumb, major pairs are always more important than crosses for at least a few reasons:
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- Because it is considering the world’s reserve currency, the US dollar, trading a major is more volatile than trading a cross. This comes from the fact that other important economies in the world are compared with the biggest one, the United States economy. It means that the currency pair will move aggressively on the news on both sides of the currency pair. Let me give you an example. Let’s assume the CPI (Consumer Price Index = inflation) is released in the Eurozone and it comes at a staggering 3% pace. This will trigger a massive buying on the EUR/USD pair as higher inflation implies the central bank will hike rates on the next meeting and interest rates are all that matters for a currency. However, on the same day, on the North American session, another important economic event may be announced, this time regarding the US economy and with implications on the US dollar. Let’s assume the FOMC (Federal Open Market Committee) Statement is released and Fed is hiking the rates. This will make the EUR/USD pair reversing ALL its previous gains based on the Eurozone inflation number and make new lows. This major pairs are volatile!
- The spread (the difference between the bid and ask prices) is always smaller on major pairs when compared with crosses. To give you an example, under the ECN (Electronic Communications Network) quotation, the spread on the EUR/USD pair can go as low as 0.2, depending on the broker, but on the AUD/NZD cross, there is always a spread way bigger than 2 or more.
Crosses, on the other hand, are not that volatile but even under the crosses a difference should be made as there are some that travel really slow (AUD/NZD, AUD/CAD, etc.) and some that move even faster than majors (EUR/AUD, GBP/CHF, GBP/JPY, etc.)
How To Make a Profit
Like mentioned above, a currency pair is always reflecting two prices: bid and ask. The bid price is the one on the left side while the ask price is the one on the right side. Buying is always made at the ask price and selling at the bid price. Let’s imagine we’re buying the EUR/USD at 1.1140 and price is moving all the way to 1.1160. Because price moved to the upside after we bought the pair, a profit has been made. In order to close the trade and book the profit, we have to sell the pair or to square the position. This is being made on the bid price, and the difference between the bid and ask price is called a spread. Needless to say that currency pairs with a lower spread are more attractive than the ones with a bigger one, and therefore brokers with lower and stable spreads are favored when compared with other ones.
What Makes a Currency Pair Move
When trading a currency pair, it is important to know what makes it move and when a movement should be expected. Therefore, the economic calendar must be known in advance for the period ahead like for the day and week in order to anticipate the move a currency pair is making. However, a currency pair is not moving only based on economic events, but also on the old fashioned supply and demand rule. If there are more traders that buy a currency pair, naturally the pair will move to the upside as a consequence. The opposite is true if more sellers dominate. In order to find out when to buy or sell a currency pair, traders use technical analysis. This allows identifying levels of support in a falling trend or resistance in a rising one as well as forecasting prices on the right side of a chart based on patterns that formed on the left side of it. Historical prices analysis can be made via trading theories and one needs access to different pieces of information from different time frames. As a rule of thumb, to more information on past prices, the more accurate the forecast of a currency pair is.
To sum up, come currency pairs are more important than other based on how fast they move or how far they travel, but the principle of trading the forex market is the same for any currency pair: buy or sell in order to make a profit.
Other educational materials
- Majors and Crosses – How to Trade Them?
- Leverage and Margin Requirements
- Forex Trading Platforms – Metatrader 4 and 5
- What is a Margin Call?
- Setting Up a Chart in Metatrader 4
- Forex Trading Accounts and the Value of a Pip
Recommended further readings
- What are Currency Pairs and the Basics of Currency Trading
- The euro as an international currency: explaining puzzling first evidence from the foreign exchange markets. Hau, H., Killeen, W., & Moore, M. (2002). Journal of International Money and Finance, 21(3), 351-383.