Understanding the major currency pairs in Forex trading

If you want to learn more about trading Forex online, you have to learn about currency pairs first.

The good news is, the basics are simple and the way in which pairs are quoted works the same for all currencies:

...from the most popularly traded ones...

...to the more exotic FX pairs.

The most popular traded currency pairs are known as the majors.

But before we look at which are the major FX currency pairs, we need to look at what a currency pair actually is.

All financial traders commonly seek a profit by speculating on the changing value of an instrument, such as the share price of a company or the worth of a commodity.

Where Forex trading differs slightly is that you are speculating on the value of one currency relative to the value of another.

The two currencies involved are known as currency pairs.

This relative value is expressed as how many units the first currency is worth in terms of the second currency.

So if the US dollar against the Japanese yen exchange rate was 113.00, it would mean one dollar was worth 113.00 yen.

It really is that simple.

The best way to get the feeling of trading currencies is to try them out on a demo account.

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How to read currency pairs

Let's look at an example to help learn how to read currency pairs.

If you were to look at live Forex prices on a trading platform, you would see a wide variety of Forex currency pairs listed.

Every currency has a three-letter ISO symbol and they are fairly straightforward.

For example:

  1. GBP is the British pound
  2. USD is the US dollar
  3. JPY is the Japanese yen
  4. CHF is the Swiss franc.

You can see it in our currency pairs.

Let's say you believe that the Euro is set to weaken because of low Euro inflation...

...and an increased chance of looser monetary policy from the European Central Bank.

In the currency pair list, you can see the Euro quoted against both the US dollar and the British pound.

The advantage Forex trading offers, is that it allows you to pick which currency you think the Euro will weaken against the most.

Let's say you think the US dollar has a good chance of strengthening against the Euro:

...because you think the Federal Reserve is more likely to tighten monetary policy...

...while the ECB is simultaneously operating a looser policy.

The currency pair you are therefore interested in, is the Euro versus the US Dollar.

To the right of the symbols for the currency pairs, there are rates at which you are able to trade.

The bid is the rate that you are able to sell a currency pair at and the ask is the rate at which you are able to buy.

These are also known as the bid and offer or sell and buy prices.

The difference between the two prices is known as the market spread.

Because you think the Euro will weaken and the US Dollar will strengthen, you want to sell the Euro and buy the US dollar.

Remember:

...a currency pair expresses how much one currency is worth relative to another currency...

...so the price quoted for the currency pair is the number of dollars per Euro.

If you are right and the Euro weakens, one Euro will be worth fewer US dollars.

In other words, the exchange rate will have gone down.

So you would be selling EUR/USD in the hopes that the rate goes down and the rate you deal at would be the bid price of 1.1036.

You always deal at the bid if you are selling the first-named currency...

...and at the ask if you are buying the first-named currency.

To reiterate, you sell if you think an exchange rate will go lower and you buy it if you expect it to rise.

You may have noticed in the list of currency pairs that the Euro was quoted first against the US dollar...

...but second when as part of a currency pair with the British pound.

In theory:

...either currency can come first (the rate being inversed if the order is reversed)...

...but in practice there are commonly-adopted conventions that place currency pairs in a certain order.

Generally, the US dollar comes first in a pair, with the notable exception of when it is quoted against the Euro or the British pound.

Liquidity in trading major Forex currency pairs

The Forex market is the most liquid market in the world, yet just a handful of currencies make up the vast majority of the market.

Regarding liquidity, it's worth reminding ourselves that:

...the larger the trade value between two countries...

...the more liquid the currency pair of these countries will be.

EUR/USD is the most liquid currency pair in the Forex market:

The most popular currency pairs are known as the majors.

There is no formal list that defines the major currency pairs or what the best currency pairs are.

But when we talk about the majors, we are usually referring to the six most actively-traded Forex pairs including:

  1. AUD/USD Australian dollar vs. US dollar
  2. EUR/USD Euro vs. US dollar
  3. GBP/USD British pound vs. US dollar
  4. USD/CAD US dollar vs. Canadian dollar
  5. USD/CHF US dollar vs. Swiss franc
  6. USD/JPY US dollar vs. Japanese yen.

Unsurprisingly, it is the currencies from the world's largest economies that comprise these Forex major pairs.

The vast amounts of trade in goods and services conducted with the nations involved is one of the reasons behind their currencies being traded so extensively.

Another reason is the political and economic stability historically associated with these currencies.

It boosts their appeal, especially in times of economic uncertainty.

The US dollar (USD) is particularly popular.

USD is supported by its status as the reserve currency of choice for central banks around the world and many key commodities (e.g. oil) are priced in US dollars.

This necessitates the currency's usage for such transactions.

After the US dollar, the Euro is the most commonly-held currency by institutions and governments alike.

Benefits of trading major currency pairs

There are varied pros and cons associated with all currency pairs, but the solid advantages of major currency pairs stem from their popularity.

You will find that news regarding these Forex pairs is more readily available.

Meanwhile, there are regular economic updates for their underlying economies:

...which are closely followed in the market...

...and therefore provide opportunities for sharp price movements in time junctures that you can anticipate.

For example, the monthly US employment situation report from the US Bureau of Labor Statistics is one of the key financial releases in the economic calendar.

Strong payroll growth in this report is seen as a proxy of economic growth as a whole.

The latter increases the chance of the Federal Reserve tightening monetary policy and making a bullish effect on the US dollar - all other things being equal.

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The tremendous liquidity of the major currency pairs provides more than one benefit.

As transaction costs are driven down by greater volumes, the more liquid currency pairs can be traded on much tighter spreads.

Greater liquidity also acts to smooth volatility in general.

It should be noted that even the most liquid currencies can still be volatile, given the right circumstances.

An extreme example of that would be the sharp plunge experienced by USD/CHF in early 2015, after the Swiss National Bank (SNB) scrapped its strategy of capping appreciation in its currency.

In the years leading up to this this incident, the safe haven nature of the Swiss franc alongside the eurozone debt crisis resulted in huge capital inflows into Switzerland.

The SNB had decided to intervene in the Forex markets - buying foreign currency to depress the Swiss franc.

When the SNB publicly abandoned the policy:

...the value of the Swiss franc snapped up like a rubber band against every other currency...

...sending USD/CHF down 25% in a matter of minutes.

Such price shocks are extremely rare.

In fact, smooth price action is a characteristic of liquid markets and extremely sharp moves are more common in less liquid markets.

The deep liquidity of the general Forex market and the major currency pairs in particular increases the ease of transactions.

The latter is opposed to financial markets with thin liquidity...

...where it may sometimes be difficult to enter or exit a trade readily.

Major Forex pairs: a good place to start?

Major Forex pairs: a good place to start?

A good way to start trading Forex is to start with what you know.

If you have insight or familiarity into a particular economy, you may naturally feel inclined to trade its currency - even if that means trading a pair that is not one of the majors.

Overall, the benefits discussed above:

...tighter dealing spreads, together with the greater availability of economic news and Forex analytics...

...mean the major currency pairs are a good way for many people to begin exploring the Forex market.