In the Forex market, traders speculate on whether the value of currencies will rise or fall. These currencies are traded in pairs, meaning that a trader is simultaneously buying one currency, while selling another.
The currencies that experience the highest trading volume are the most liquid forex pairs and known as the Majors:
|New Zealand dollar||(NZD)|
What Currency Pairs to Trade
For beginners starting out in Forex trading, one of the first questions is often “what are the best currency pairs to trade?”. To answer this, we must first look at the different types of currency pairs available, and how they are categorised. Currency pairs are separated into 3 distinct categories:
- Major Currency Pairs
- Cross-Currency Pairs
- Exotic Pairs
Major Currency Pairs
The top traded currency pairs are called Major currency pairs. These all involve the U.S. dollar (USD) being paired with one of the other Major currencies and are included in the list below:
|EUR/USD||(the euro paired with the U.S. dollar)|
|USD/JPY||(the U.S. dollar paired with the Japanese yen)|
|GBP/USD||(the British pound paired with the U.S. dollar)|
|USD/CHF||(the U.S. dollar paired with the Swiss franc)|
|USD/CAD||(the U.S. dollar paired with the Canadian dollar)|
|AUD/USD||(the Australian dollar paired with the U.S. dollar)|
|NZD/USD||(the New Zealand dollar paired with the U.S. dollar)|
Currency pairs that do not include the USD are called Cross-Currency pairs, with crosses between the other Major currencies referred to as Minors. The most frequently traded Cross-Currency pairs include at least one of the three other Major currencies, excluding the USD, i.e. EUR, JPY and GBP. Some examples of Cross-Currency Pairs include:
|EUR/GBP||(the euro paired with the British pound)|
|EUR/CHF||(the euro paired with the Swiss franc)|
|EUR/JPY||(the euro paired with the Japanese yen)|
|GBP/JPY||(the British pound paired with the Japanese yen)|
|AUD/CHF||(the Australian dollar paired with the Swiss franc)|
|NZD/CAD||(the New Zealand dollar paired with the Canadian dollar)|
Exotic Currency Pairs
Currency pairs that include one of the major currencies paired with that of an emerging economy are called Exotic Currency Pairs. Due to the limited volume of trades conducted on these pairs, the liquidity for them is low. As such, they can incur wider spreads, meaning it costs traders more to trade them.
Some examples of Exotic Currency Pairs can be seen in the list below:
|USD/HKD||(the U.S. dollar paired with the Hong Kong dollar)|
|CAD/MXN||(the Canadian dollar paired with the Mexican peso)|
|EUR/SEK||(the euro paired with the Swedish krona)|
|JPY/SGD||(the Japanese yen paired with the Singapore dollar)|
Having understood the different types of currency pairs, and how they are categorised, we can return to the question posed at the beginning of this section: “what are the best currency pairs to trade?”.
For beginners who are just starting out in the world of Forex trading, it is recommended to stick to trading the most liquid Forex pairs available. This means that the Major currency pairs listed above are a beginner’s best choice. The reasons for this include:
- The liquidity of these top traded currency pairs, arising from the large volumes being traded, mean that transaction costs such as spreads are much lower than with other pairs
- As the Major pairs include currencies from key nations in the global economy, there is more news available that traders can use to inform their trading decisions
In comparison, it is recommended that Exotic currency pairs, which suffer from low trading volumes, and thus low liquidity, should be avoided by traders with limited experience, as these are prone to volatility and can incur significantly higher transaction costs.
How Do Currency Pairs Work?
So far we have covered what currency pairs are, how they are categorised and which ones are best for beginners to start trading. But how do currency pairs work?
As previously mentioned, in Forex trading you are simultaneously buying one currency and selling another. To understand this a little better, we will use one of the most active currency pairs, EUR/USD, as an example.
When trading EUR/USD, you are simultaneously buying euros and selling U.S. dollars. The first currency in a pair, in this example the euro, is known as the ‘base currency’. The second currency in a pair, which in this case is the U.S. dollar, is called the ‘quote currency’ or ‘term currency’. The current exchange rate for the pair is 1.0739, meaning that to buy 1 euro, you need to sell 1.0739 U.S. dollars. Conversely, when selling 1 euro, you will receive 1.0739 U.S. dollars. Bear in mind that, in any Forex trade, the base currency is the basis for the trade. So, if you are buying EUR/USD you will be purchasing euros and selling U.S. dollars, whereas if you are selling EUR/USD, you will be selling euros and buying U.S. dollars.
In Forex trading, initiating a trade is referred to as ‘opening a position’ and ending a trade is known as ‘closing a position’. Let’s return to our example of using EUR/USD. If you were to open a position by buying 100,000 euros at the current market price, you would then have to sell 100,000 euros to close the position. You would then accept the difference between the opening and closing prices as either profit or loss. Conversely, if you were to open a position by selling 100,000 euros, to close the position you would have to buy 100,000 euros.
How to Know When to Buy and When to Sell
Another question that beginners may have when starting to trade Forex is “how do I know when to buy and when to sell a currency pair?”. To answer this, we must first look at what it actually means to buy or sell a currency pair.
The price of a currency reflects how the market views the current and future state of a country or region’s economic health. For example, the value of the U.S. dollar is a reflection of how the market perceives the present and future economic health of the United States, at that specific moment in time.
So, when buying or selling currency pairs, traders are in fact speculating on the performance of a country’s economic health against that of another country. Returning to our previous example of EUR/USD, if a trader believes that the euro area’s economy will outperform that of the United States, they would buy euros and sell U.S. dollars, expecting the value of the former to increase, or appreciate, while that of the latter decreases, or depreciates. On the other hand, if a trader expects the United States’ economy to outperform the euro area’s, they would buy U.S. dollars and sell euros. If the trader’s assumption is correct, they will earn a profit upon closing the position. If, however, the market moves against them, they will incur a loss.
Having understood what it means to buy or sell a currency pair, we can now answer the original question of how a trader can know when to take the appropriate position. Although there can never be a guarantee of how the market will move, there are a variety of methods that traders can use to make the most informed decisions possible:
- Economic announcements are released frequently for the countries involved in the top traded currency pairs. These announcements can have significant effects on the market. By staying informed, traders can anticipate potential currency movements
- Following global news regarding the countries whose currencies a trader is interested in is also important. Other than economic announcements, new government policies, elections, trade deals, and other news, could all potentially affect a currency’s value
- Traders also have a range of tools at their disposal that can help them analyse the markets, and predict potential new trends that currencies may follow
Did you know that many of the currency pairs traded on the Forex market have their own nicknames? Traders, market analysts and journalists will often refer to pairs by their nicknames, a list of which can be found below:
Aussie-dollarRefers to the currency pair between the Australian dollar and the U.S. dollar (AUD/USD)
BarnieRefers to the currency pair between the U.S. dollar and the Russian rouble (USD/RUB). The term alludes to the character ‘Barnie Rubble’ from ‘The Flintstones’
BettyRefers to the currency pair between the euro and the Russian rouble (EUR/RUB). The term alludes to the character ‘Bettie Rubble’ from ‘The Flintstones’
CableRefers to the currency pair between the British pound and the U.S. dollar (GBP/USD). The term originates from the 19th century, when the pair’s exchange rate was transmitted across the Atlantic Ocean via a submarine communications cable
ChunnelRefers to the currency pair between the euro and the British pound (EUR/GBP). The term is an abbreviation for the Channel Tunnel that connects Britain and France
Euro-swissyRefers to the currency pair between the euro and the Swiss franc (EUR/CHF)
FiberSometimes used to refer to the currency pair between the euro and the U.S. dollar (EUR/USD). The term is thought to originate from that fact that the paper used to print euro banknotes is made of pure cotton fiber
Guppy or Gopher or GeppyAll three terms refer to the currency pair between the British pound and the Japanese yen (GBP/JPY). Of the three, ‘Guppy’ is the most often used
KiwiRefers to the currency pair between the New Zealand dollar and the U.S. dollar (NZD/USD)
NinjaRefers to the currency pair between the U.S. dollar and the Japanese yen (USD/JPY)
YuppyCertain currencies also have their own nicknames, some of which mirror those of currency pairs they are involved in. These include the Aussie (AUD), Cable (GBP), Fiber (EUR), Kiwi (NZD), Loonie (CAD), Single Currency (EUR) and Swissy (CHF).