Understanding Currency Pair Trading

What is forex trading?

Forex trading involves the simultaneous purchase of one currency and the sale of another.

Currency transactions take place through entities known as "forex brokers" or "CFD providers," and they occur in pairs, with currencies being quoted in relation to each other.

For instance, consider the euro and the U.S. dollar (EUR/USD) or the British pound and the Japanese yen (GBP/JPY).

When engaging in forex trading, you are essentially trading in currency pairs.

Think of each currency pair as if it's engaged in an ongoing "tug of war," with each currency representing one side of the rope.

An exchange rate represents the relative value of two currencies from different countries, and this rate fluctuates based on the relative strength of the involved currencies.

There are three primary categories of currency pairs:

1. The "majors," which invariably include the U.S. dollar.
2. The "crosses," which do not involve the U.S. dollar. Crosses that include any of the major currencies are commonly referred to as "minors."
3. The "exotics," which consist of one major currency and one currency from an emerging market (EM).

Major Currency Pairs

The following currency pairs are categorized as the "majors."

These pairs exclusively feature the U.S. dollar (USD) on one side and are among the most heavily traded in the forex market.

Despite there being EIGHT major currencies in total, there are only SEVEN major currency pairs.

In contrast to the crosses and exotics, the majors exhibit more frequent price fluctuations, offering a greater number of trading prospects.

The majors are renowned for their exceptional liquidity.

Liquidity is a term used to gauge the extent of activity within the financial market.

In the forex realm, it is determined by the number of active traders engaging in transactions involving a particular currency pair and the corresponding trading volume.
Greater trading frequency corresponds to higher liquidity.

For instance, the EUR/USD currency pair experiences more extensive trading activity and higher transaction volumes than the AUD/USD currency pair.

This disparity signifies that EUR/USD boasts superior liquidity compared to AUD/USD.

Major Cross-Currency Pairs or Minor Currency Pairs

Currency pairs involving any combination of the major currencies, excluding the U.S. dollar, fall under the category of cross-currency pairs, commonly referred to as the "crosses."

Crosses that involve major currencies are alternatively known as "minors."

Although they do not see the same level of trading activity as the majors, the crosses still maintain a notable level of liquidity, presenting ample opportunities for trading.

The most actively traded cross-currency pairs stem from the three primary non-USD currencies: EUR, JPY, and GBP.

Euro Crosses

Yen Crosses

Pound Crosses

Other Crosses

Exotic Currency Pairs

Exotic currencies originate from countries with developing or emerging markets.

Exotic currency pairs consist of one major currency paired with the currency of an emerging economy, such as Brazil, Mexico, Chile, Turkey, or Hungary.

In essence, an exotic currency pair combines a major currency with an exotic one.

Below, you'll find a few examples of exotic currency pairs. Care to take a guess at the meaning behind those other currency symbols?

Depending on your chosen forex broker, you might encounter the following exotic currency pairs, so it's beneficial to acquaint yourself with them.

It's important to note that these pairs do not see as much trading activity as the "majors" or "crosses," leading to generally higher transaction costs when trading them.

It's not uncommon to encounter spreads that are two or even three times larger in exotic currency pairs compared to those in EUR/USD or USD/JPY.

Because of their generally lower liquidity, exotic currency pairs tend to exhibit heightened sensitivity to economic and geopolitical developments.

For instance, an unexpected political scandal or election results can lead to significant and abrupt swings in the exchange rate of an exotic pair.

Therefore, if you're considering trading exotic currency pairs, it's essential to take these factors into consideration before making your decision.

And for those of you who are particularly fascinated by exotic pairs, here's a more comprehensive list.

In addition to the three primary categories of currency pairs, there are additional "groups" of currencies frequently discussed in the world of forex that it's important to be aware of.

G10 Currencies

The G10 currencies represent a set of ten of the world's most actively traded and highly liquid currencies.

These currencies are regularly bought and sold in the open market, and their transactions have minimal influence on their respective international exchange rates.

The Scandies

Scandinavia, situated in Northern Europe, shares deep historical, cultural, and linguistic connections.

In local terminology, "Scandinavia" encompasses the three kingdoms of Denmark, Norway, and Sweden.

Collectively, their currencies are referred to as the "Scandies."

Historically, Denmark and Sweden initiated the Scandinavian Monetary Union, which linked their currencies to the gold standard. Norway later joined this union.

This arrangement meant that these nations shared a common currency with identical monetary values, though each country minted its own coins.

However, with the advent of World War I, the gold standard was abandoned, leading to the dissolution of the Scandinavian Monetary Union. Despite this, these countries opted to retain their individual currencies, even though their values were no longer fixed. This arrangement persists to this day.

Notably, if you examine the names of their currencies, they all exhibit a striking similarity. This is because the term "krone" or "krona" directly translates to "crown," with variations in spelling reflecting the distinctions among the North Germanic languages.

Indeed, "crown currencies" carries a certain allure, doesn't it? Saying "Hook me up with some crowns, yo" definitely has a unique flair compared to the more common "Hook me up with some dollars, yo.

SEK and NOK come with some fun nicknames: "Stockie" for SEK and "Nokie" for NOK.

Consequently, when these currencies are paired with the U.S. dollar, we say USD/SEK as "dollar stockie" and USD/NOK as "dollar nockie."

CEE Currencies

"CEE" stands for Central and Eastern Europe.

Central and Eastern Europe is a term that encompasses countries in Central Europe, the Baltics, Eastern Europe, and Southeast Europe (the Balkans). Typically, it refers to the former communist states that were part of the Eastern Bloc (Warsaw Pact) in Europe.

The Central and Eastern European Countries (CEECs) is a designation used by the OECD for a group of countries. This group includes Albania, Bulgaria, Croatia, the Czech Republic, Hungary, Poland, Romania, the Slovak Republic, Slovenia, and the three Baltic States: Estonia, Latvia, and Lithuania.

In the context of the foreign exchange (FX) market, it's important to be aware of the four primary CEE currencies.

BRIICS

The acronym "BRIICS" represents the collective association of six significant emerging national economies: Brazil, Russia, India, Indonesia, China, and South Africa.

Initially, the first four countries were grouped together as "BRIC" (or "the BRICs"). "BRICs" was a term coined by Goldman Sachs to describe the emerging high-growth economies of today.

The term "BRIICS" came into existence through the OECD, which incorporated Indonesia and South Africa into the original BRIC grouping.

Summary

Phew! That was quite a bit of currency information, and your FX knowledge just received a boost! 🧠

Let's summarize what you've learned through a series of questions:

What constitutes a currency pair in forex?

A currency pair is a combination of two currencies where the value of one currency is relative to the other. For instance, GBP/USD reflects the value of the British pound compared to the U.S. dollar.

Which currency pairs are considered major?

Major currency pairs, often referred to as "majors," include the U.S. dollar and are the most frequently traded. There are seven of them: EUR/USD, USD/JPY, GBP/USD, USD/CAD, USD/CHF, AUD/USD, and NZD/USD.

What defines currency crosses?

Currency crosses, known as "crosses," consist of currencies that are traded more frequently and do not involve the U.S. dollar in their pairing. Crosses encompass pairs like EUR/GBP, EUR/CAD, GBP/JPY, EUR/CHF, EUR/JPY, and so on.

How many currency pairs are there in total?

There are HUNDREDS of currency pairs in existence, but not all of them are tradable in the FX market. Currently, the United Nations recognizes 180 different currencies. If you were to pair each of these currencies with another, it would indeed amount to a substantial number.