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During trading Forex investors often come across terms like minor and major currency pairs, what does that exactly mean? What are the main things to know about the currency pairs and what exactly are base and quote currencies?
In this guide, you’ll get more detailed information about the currencies, more specifically, about base and quote currencies, what are they, why should you know something about them, and why it’s important to have some basic information about how they work in Forex.
What Are Forex Currency Pairs?
Until going into depths and get more information about the base and quote currencies, let’s see what are Forex currency pairs and how they work. It’s clear that the Foreign exchange market, which is one of the largest markets in the world, involves trading with currencies and that’s one of the main reasons why traders need to understand currency pairs. For trading, buying, or selling, and trade-related processes it’s important to trade with currency pairs. Currency pair means that you take more than one currency and no more than two currencies to trade with. The currency pair and its exchange rate define what are the exact price in a certain currency to get a concrete, the second currency.
To make it more simple, let’s take an example. Imagine that you are a trader and you want to trade with the currency pairs. The first thing you do is researching and analyzing market tendencies. After that, you decide which will be the best pair among others to trade with and get profits. For example, you decided to start trading with the minor Forex pairs like EUR/GBP. In this case, let’s say that the exchange rate is 0.8968, which means that you can get 0.8968 GBP for 1 EUR.
Forex Currency Pairs Types Explained
As already mentioned, Forex trading is linked to trading with currency pairs. So, traders need to decide whether it worth it to trade with certain currency pairs or not or whether it will be beneficial and profitable for them or not. In this case, one of the main roles for coordinating and deciding what will be your strategy has the types of Forex currency pairs. In general, there are three main types of currency pairs including major, minor (also known as currency cross pairs), and exotic.
Major currency pairs are the currency pairs, that are the most frequently traded in Forex. The main reason which stands behind the high demand of the currencies is currency’s liquidity. If a certain currency has high liquidity it means that there’s a lower risk of changing prices instantly and in a little time, and through the higher liquidity traders can get tighter bid-offer spreads or lower brokerage costs. Because of the mentioned advantages, traders are trading more often with major currencies. Some of the major currencies are EUR/USD, USD/GBP, USD/AUD, CHF/USD. It’s easy to notice that all the mentioned currency pairs have one thing in common – USD. That’s because the USD is the currency, which is widely used and is the world’s leading reserve currency. Moreover according to the statistics trading with USD in Forex is up to 80%, which is quite a big index and shows how massive USD’s liquidity is and how liquidity affects the strengthening of a certain currency. So, it can be said, that the USD is the default target currency.
As already mentioned other types of currency pairs are minor currency pairs. Minor currency pairs also known as cross-currency pairs are those pairs, where the trader doesn’t trade through USD. However, that doesn’t necessarily mean that the trader doesn’t trade through most traded currencies. On the contrary, currency pairs are minor when the trader decides to trade with the currency pairs that are highly demanded but don’t include the US dollar. Even though that investors in most cases trade with major currency pairs, trading through minor currency pairs is getting more and more popular among them as well. Some of the minor currency pairs are EUR/GBP, CAD/EUR, JPY/EUR, and so on.
Furthermore, other types of currency pairs are exotic currency pairs. Currency pairs are exotic when among the pairs there is a rare, not very popular traded currency, and among them, there can be the most volatile Forex pairs as well. In this case, in contrast with the minor currencies traders are allowed to trade with USD, however, the main condition is to have a currency, which isn’t as popular as minor and major currencies, Some of the exotic currency pairs are USD/TRY, EUR/NOK, GBP/SGD, USD/ZAR.
Traders are questioning in most cases what are the most profitable currency pairs to trade. There is no one answer to the mentioned question. It all depends on the preferences of the trader, strategy, and main goals. Firstly, the trader needs to research and analyze currencies’ price change tendency, use some of the features like economic calendar, analytical tools, which are provided both by brokers and trading platforms.
What Are Base and Quote Currencies?
For understanding how to read currency pairs traders need to know terms like base and quote currencies. To make it more simple to understand let’s take an example. Imagine that you are a trader and you prefer to trade with major currency pairs like EUR/USD. In this case, the currency EUR is a base currency, while the US dollar is a quote currency. The base currency is a currency, which you want to take as a major. It defines what is the amount of money you can get with 1 base currency. The mentioned abbreviations are prescribed by the International Organization for Standardization. Currency pairs are always defined with the three symbols. For example, if one of the trading currency pairs is a Euro, it can be shown on the trading platform and in the list of currencies as EUR. After understanding the base currency meaning, it’s time to give you a more detailed explanation of the quote currencies. In contrast with the base currency, it should be said, that the quote currencies are the second part of the quotation. Quote currencies are also known as reporting currency and it shows the amount of money, which can be taken through the 1 base currency. So, to make it more clear and easy to understand, let’s take an example. Imagine, that you as a trader want to trade with the currency pairs like CAD/EUR. In this case, as the second part of the quotation is a Euro, it is the quote currency.
Factors That Affect Currency Values
While trading Forex there are some significant things that you need to consider. Until you start trading, as already mentioned, you need to do some research, see news reports and decide whether it worth it to trade with a certain currency or not. In this part, you’ll get more information about the factors that have a crucial effect on currency values.
Inflation Rate
Firstly, one of the main things, that affect currency values is the inflation rate. Through the rising inflation rate, people can buy fewer things with a certain amount of money. When inflation happens this means that the concrete currency is becoming weak. Moreover, some factors have the influence or fishing the inflation rate including the government’s debts. Inflation hinders the development of a country’s economy and makes the products more expensive as the rate goes higher. When the inflation rate is high and the country has a big amount of debts including national or foreign debts, there is a much lower chance of acquiring foreign capital.
Interest Rate
Another important factor, which affects currency values is interest rates. Interest rates and inflation rates are in most cases highly linked. Interest rate defines the index of the demand on a certain currency. When the inflation rate is lower and there’s a quite well economic environment in a particular country, there’s more chance of acquiring foreign capital by the country. To make it more simple, imagine that you live in Australia and your national currency is AUD. After Australia’s interest rate increases compared to other countries, it starts to attract more traders and more foreign capital, as well. Through this process, traders can get high returns and because of the higher profits the demand on the Australian dollars increases, which means that the interest rate rises, as well. This makes a certain national currency stronger and leads to economic growth.
Monetary Policy
The monetary policy and laws, which are linked to the financial sector have a vital role while defining a certain currency’s value. For example, if the country decides for some reason to reduce the number of foreign investments in the country, this may lead the country to a recession, which besides may cause a depreciation in the exchange rate. On the contrary, if the recession makes the inflation rate decrease, this may lead to positive changes and growing demand for a certain currency. Increased demand, on the other hand, is the cornerstone of the currency to become stronger.
Tourism
In the world where we live tourism has an important role. People are traveling all around the world and spending their money. If the tourism rate grows this means that the exchange rate of the specific currency and its value rises, as well. To make it more simple, imagine that you are a traveler who travels from EU country to the USA. In EU countries the national currency is defined as Euro, but you can’t spend the mentioned currency outside the EU countries. This means that you have to exchange EUR into USD, which is the national currency of the USA. In this case, the demand for the USD rises, because you need to spend the mentioned currency. And as the demand for the specific currency rises it has a positive effect on the currency’s value, in this case on the value of the USD.
Geopolitical Stability
One of the key factors, which affect the currency value is geopolitical stability. As long as geopolitical stability means a lot to create an attractive environment for the investors it plays a dominant role in defining the concrete currency value. In the case of political stability people usually are using the term of Geopolitical risk. Geopolitical risk is higher if the chances of wars, economic instability, and so on are most likely to happen. When there’s a high risk, investors aren’t attracted and starting to avoid making investments in a certain country. That’s because the geopolitical processes are defining the currency value. It’s clear without saying, that investors are seeking profits, and aren’t attracted to the countries where the chance of losing money is higher.
What Are the Differences Between Forex Currency Pairs and Other Securities?
Forex market and Foreign Exchange-related processes are most likely to conduct for 24 hours a day, during working days. So, this means, that the popularity of FX trading is one of the main differences between other securities. People can exchange one currency against another, get profit and earn money. It goes without saying that all the processes in the FX market are quite easy and supportive for all the users both experienced and inexperienced ones. In contrast with securities like stocks, traders don’t need to exchange their profit in currencies, instead, all the earned money is already given in a certain currency, which allows traders to save time and get deserved profits easily. What’s important, people who are involved in Forex trading can get numerous supportive and helpful features through the brokers and trading platforms.