Understanding Currency Pairs for Dummies

Understanding Currency pairs is a basic idea in the foreign exchange market. It’s where one type of money is swapped for another. They’re shown as a ratio, which tells you how much of one currency you need to buy or sell a unit of the other currency.

Understanding Currency Pairs

A currency pair is a price quote of two different types of money. The value of one currency is quoted against the other. The first listed currency is the base currency, and the second is the quote currency.

For example, in the currency pair EUR/USD, EUR is the base currency, and USD is the quote currency. If EUR/USD is quoted as 1.20, 1 Euro (EUR) equals 1.20 US Dollars (USD).

Types of Currency Pairs

Currency pairs are grouped into three types: major pairs, minor pairs, and exotic pairs.

1. Major Currency Pairs: These are the seven currency pairs, including the US Dollar (USD), making up about 80% of global forex trading volume. They include EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF, NZD/USD, and USD/CAD.

2. Minor Currency Pairs: Also known as cross-currency pairs or simply “crosses,” these pairs do not include the US Dollar. Examples include EUR/GBP, EUR/AUD, GBP/JPY, and EUR/CHF.

3. Exotic Currency Pairs: These pairs consist of a major currency paired with the currency of a developing economy, such as Brazil, Mexico, or South Africa. An example is USD/ZAR (US Dollar/South African Rand).

How to Read Currency Pairs?

When you see a forex quote like GBP/USD = 1.39, 1 British Pound (GBP) can be swapped for 1.39 US Dollars (USD). You would buy this pair if you think the GBP will get more robust against the USD. On the other hand, if you think the GBP will weaken against the USD, you would sell this pair.

Example Transactions

Let’s look at an example with the EUR/USD pair to understand how a forex transaction works:

Suppose EUR/USD is trading at 1.20, and you expect the Euro to get more robust against the US Dollar. You decide to buy €10,000 at this rate. This means you will need $12,000 (€10,000 * 1.20) for this transaction.

Suppose EUR/USD rises to 1.25 a few days later due to good economic news from Europe. You decide to sell your €10,000 at this new rate. You receive $12,500 (€10,000 * 1.25), making a profit of $500 ($12,500 – $12,000).

Conclusion

Understanding currency pairs is very important for anyone starting forex trading. By knowing how to interpret currency pairs and their movements, traders can make informed decisions and potentially profit from these movements.