Understanding Currency Pairs


A currency pair is the quotation of the relative value of a foreign exchange market. The currency that is used as the reference is called the counter currency or quote currency and the currency that is quoted in relation is called the base currency or transaction currency.

Currency pairs are sometimes then written by concatenating the US dollar, designated as EUR/USD. The quotation EUR/USD 1.2500 means that one euro is exchanged for 1.2500 US dollars.

The most traded currency pairs in the world are called the Majors. They involve the currencies Swiss franc.

Contents

Syntax and quotation

Currency quotations use the abbreviations for currencies that are prescribed by the Swiss franc (CHF).

As has been mentioned previously, the quotation EUR/USD 1.2500 means that one euro is exchanged for 1.2500 US dollars. If the quote changes from EUR/USD 1.2500 to 1.2510, the euro has increased in relative value, because either the dollar buying strength has weakened or the euro has strengthened, or both. On the other hand, if the EUR/USD quote changes from 1.2500 to 1.2490 the euro is relatively weaker than the dollar.

Base currency

Most traded currencies by value
Currency distribution of global foreign exchange market turnover[1]
Rank Currency ISO 4217 code
(Symbol)
 % daily share
(April 2010)
1
United States dollar
USD ($)
84.9%
2
Euro
EUR (€)
39.1%
3
Japanese yen
JPY (¥)
19.0%
4
Pound sterling
GBP (£)
12.9%
5
Australian dollar
AUD ($)
7.6%
6
Swiss franc
CHF (Fr)
6.4%
7
Canadian dollar
CAD ($)
5.3%
8
Hong Kong dollar
HKD ($)
2.4%
9
Swedish krona
SEK (kr)
2.2%
10
New Zealand dollar
NZD ($)
1.6%
11
South Korean won
KRW (₩)
1.5%
12
Singapore dollar
SGD ($)
1.4%
13
Norwegian krone
NOK (kr)
1.3%
14
Mexican peso
MXN ($)
1.3%
15
Indian rupee
INR (INR)
0.9%
Other 12.2%
Total[2] 200%

The rules for formulating standard currency pair notations result from accepted priorities attributed to each currency.

From its inception in 1999 and as stipulated by the European Central Bank, the euro has first precedence as a base currency. Therefore, all currency pairs involving it should use it as their base, listed first. For example, the US dollar and euro exchange rate is identified as EUR/USD.

Although there is no standards-setting body or ruling organization, the established priority ranking of the major currencies is:

Historically, this was established by a ranking according to the relative values of the currencies with respect to each other[citation needed], but the introduction of the euro and other market factors have broken the original price rankings.

Other currencies (the Minors) are generally quoted against one of the major currencies. These pairs are also referred to as currency crosses, or simply crosses. The most common crosses are EUR, JPY, and GBP crosses.

The term base currency in the foreign exchange field is also used as the accounting currency by banks, and is usually the domestic currency. For example, a British bank may use GBP as a base currency for accounting, because all profits and losses are converted to the sterling. If a EUR/USD position is closed out with a profit in USD by a British bank, then the rate-to-base will be expressed as a GBP/USD rate. This ambiguity leads many market participants to use the expressions currency 1 (CCY1) and currency 2 (CCY2), where one unit of CCY1 equals the quoted number of units of CCY2.

The Majors

The most traded pairs of currencies in the world are called the Majors. They constitute the largest share of the foreign exchange market, about 85%,[market liquidity.

The Majors are: EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF and USD/CAD.[3]

Nicknames

In everyday foreign exchange market trading and news reporting, the currency pairs are often referred to by nicknames rather than their symbolic nomenclature. These are often reminiscent of national or geographic connotations. The GBP/USD pairing is known by traders as the [5] Nicknames vary between the trading centers in New York, London, and Tokyo.

Cross pairs

The currency pairs that do not involve the US dollar are called cross currency pairs, such as GBP/JPY. Pairs that involve the euro are often called euro crosses, such as EUR/GBP. There are many local sites providing these types of local currency crosses

Trading

Currencies are traded in fixed contract sizes, specifically called lot sizes, or multiples thereof. The standard lot size is 100,000 units of the base currency. Many retail trading firms also offer 10,000 unit (mini lot) trading accounts and a few even 1,000 unit (micro lot).

The officially quoted rate is a pips. In general, markets with high liquidity exhibit smaller spreads than less frequently traded markets.

The spread offered to a retail customer with an account at a brokerage firm, rather than a large international forex citation needed]

Example:- lets consider EUR / USD currency pair EUR / USD — 1.33 Base currency/Quote currency

In the above case if you are buying 1EUR you will have to pay 1.33 USD conversely if you are selling 1EUR you will receive 1.33 USD (assuming no FX spread). Forex traders Buy EUR / USD pair if they believe that EUR would increase in value relative to USD, buying EUR / USD pair this way is called going long on the pair; converseley, would sell EUR / USD pair called going short on the pair, if they believe the value of EUR will go down relative to USD. It is noteworthy, that a pair is depicted only oneway and never reversed for the purpose of a trade, but a buy or sell function is used at initiation of a trade. Buy a pair if bullish on the first position as compared to the second of the pair; conversely, sell if bearish on the first as compared to the second.

See also

References

  1. http://bis.org/publ/rpfxf10t.pdf. Retrieved 2 May 2011.
  2. ^ The total sum is 200% because each currency trade always involves a currency pair.
  3. http://www.bis.org/publ/rpfxf07t.htm, retrieved October 6, 2009
  4. ^ Currency pairs: what Forex traders should know
  5. ^ [1] FXDD “Dynamics of Currency Pairs”, fxdd.co, published 30 June 2012, retrieved 07 November 2012

External links

This article uses material from the Wikipedia article Currency Pair, which is released under the Creative Commons Attribution-Share-Alike License 3.0.

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