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Saturday, 20 April 2013

The basics of understanding Currency pairs


Forex trading is the simultaneous buying of one currency and the selling of another and is always done in currency pairs, such as GBP/USD or USD/CAD. A currency pair represents the exchange rate between the two currencies.

The first currency in a currency pair is always dominant and called the Base Currency. It is also the currency that remains constant when determining a currency pair's price. The Counter Currency or pricing currency is the second currency in a currency pair notation.
For example, a transaction of buying the EUR/USD at 1.3000 is actually buying the Euro and selling the Dollar at 1.3000 cent. If the Euro increases in value in relation to the dollar, the price will increase and the currency trader will make money on his transaction. 

Base and Counter Currency
How is forex quoted? 
Like equities, foreign exchange has a bid price and an ask price.  The bid price is where the market maker is willing to buy. The ask price, is where the market maker is willing to sell. For traders, the reverse is true. The bid price is where a trader can sell, while the ask price is where a trader can buy. The bid price is always less than the ask price. This makes logical sense, as a market maker, like any investor, wants to buy low and sell high. The spread between the bid and the ask price is called the bid/ask spread or dealing spread.
Like equities, foreign exchange has a bid price and an ask price.  The bid price is where the market maker is willing to buy. The ask price, is where the market maker is willing to sell. For traders, the reverse is true. The bid price is where a trader can sell, while the ask price is where a trader can buy. The bid price is always less than the ask price. This makes logical sense, as a market maker, like any investor, wants to buy low and sell high. The spread between the bid and the ask price is called the bid/ask spread or dealing spread. 

Dealing Spread

 
Examples: 
SymbolCurrencyNickname
USDUnited States DollarBuck
GBPGreat Britain PoundCable
JPYJapanese YenYen
CHFFrancSwissy
CADCanadian DollarLoonie
NZDNew Zealand DollarKiwi
AUDAustralian DollarAussie
EUREuroFiber

Three main types of currency pairs are: 

  • The majors: EUR/USD, USD/JPY, USD/CHF and GBP/USD.
  • The commodity pairs: USD/CAD, AUD/USD and NZD/USD. 
  • The currency crosses: most popular are the EUR/GBP, EUR/JPY and EUR/CHF.


The "Major" currency pairs 
Currencies, like equities and bonds, have pairs that are very liquid and those that are not so liquid.  The liquid currencies can be characterized as those that are the most stable economically, and politically. They include the countries that form the Group of 7 or G7 - the United States, Japan, Great Britain, France, Germany, Italy, and Canada.
Often you will hear on CNBC or read in the financial press that the "dollar was stronger today".  When that is said, it usually implies that the dollar got stronger vs. the major currencies or what is often referred to as the“Majors”. Since the unification of the European currencies into the Euro, the currencies that are most liquid now include the US Dollar, the Japanese Yen, the British Pound, and the Euro, known as the “major pairs”. It is estimated that activity in these currencies comprises of more that 85% of the daily foreign exchange volume.
The following are examples of situations that might lead you to choose a particular currency pair to trade: 
USD/CHF

USD/CHF


Foreign currency symbols
Foreign Currencies like equities have their own symbols that distinguish one from another.  Since foreign currencies are quoted in terms of the value of one currency against the value of another, a currency pair includes the "name" for both currencies, separated by a "/".  The "name" is a three-letter acronym. The first two letters are in most cases reserved for identification of the country. The last letter is the first letter of the unit of currency for that country.     
 EUR/USD 
• Dollar weakness drives EUR/USD higher • US recovery and strong influx of foreign demand will send EUR/USD lower 
 USD/JPY
   • Japanese government intervention to weaken their currency sends USD/JPY higher • Gains in Nikkei and demand for Japanese assets drive USD/JPY down.
 GBP/USD 
• High yield and attractive growth in the UK drives GBP/USD higher • Speculation about UK adopting the euro will send the GBP/USD lower.
 • Global stability and global recovery will send USD/CHF higher • USD/CHF rallies on geopolitical instability.

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