Understanding the Major Currency Pairs in Forex Trading
Reading time: 10 minutes
If you want to learn more about trading Forex online, you have to learn about currency pairs first. The good news is that the basics are simple, and the way in which pairs are quoted works the same for all currencies. From the most popular, and regularly 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. When the two currencies involved are grouped and valued against each other, they known as a currency pair.
This relative value is expressed as how many units the first currency is worth in relation to the second currency. So if the US dollar is being valued against the Japanese Yen, and the exchange rate was 113.00, it would mean that one dollar was worth 113.00 yen. It really is that simple. Arguably, the best way to start trading currencies and gain an initial understanding of them is to try them out on a demo account. This way, you avoid risking your capital, as you can trade in a risk-free trading environment with virtual funds, until you are ready to transition to a live account.
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 (International Organization for Standardization) symbol, and they are fairly straightforward.
- GBP is the British Pound
- USD is the US Dollar
- JPY is the Japanese Yen
- CHF is the Swiss Franc.
Let's say you believe that the Euro is set to weaken because of low Euro inflation, and that there is an increased chance of looser monetary policy from the European Central Bank (ECB). 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 that you think the US dollar has a good chance of strengthening against the Euro: this might be 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 (EURUSD). 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. Supposing that you think the Euro will weaken, and the US Dollar will strengthen, you will likely 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.
If you'd like to learn more about Forex price quotes, why not check out our dedicated article on the topic?
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 inverted 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, and 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:
- AUD/USD - Australian dollar vs. US dollar
- EUR/USD - Euro vs. US dollar
- GBP/USD - British pound vs. US dollar
- USD/CAD - US dollar vs. Canadian dollar
- USD/CHF - US dollar vs. Swiss franc
- 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 and Cons 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.
However, this is not without a significant amount of work, as being successful in the Forex markets requires traders to be constantly monitoring news developments, economic announcements, forecasts, and other kinds of data. Traders must follow all of these important types of data, all while monitoring price fluctuations within their chosen currency pairs. It is clear therefore, that one of the major cons associated with trading Forex is that it requires a great deal of attention, and a lot of regular research, and even then, this may not necessarily lead to traders achieving high returns.
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 producing a bullish effect on the US dollar - all other things being equal. 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. Volatility itself can be regarded as a con for short-term Forex traders. If they're not prepared or aware of the sudden shifts that the market can take, they could potentially lose a substantial amount of capital.
It's therefore recommended for professional Forex traders to exercise risk management within their trading, to make sure that they minimise the risks as much as possible. An extreme example of extreme price volatility would be the sharp plunge experienced by the USD/CHF currency pair in early 2015, after the Swiss National Bank (SNB) scrapped its strategy of capping appreciation within 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 like a rubber band against every other currency, sending the USD/CHF currency pair down by 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.
One potential con of trading in the Forex markets is the inability to receive the type of regular, reliable, and fixed returns you can usually expect to receive with other types of investments, such as stocks or bonds. This all depends on your outlook. For some traders, Forex simply doesn't provide enough value for the risk involved, but for others, the short-term nature of the market allows for traders to potentially earn a lot (or lose a lot) in a short space of time. Perspective it would seem, is a major factor in deciding whether or not to trade in the Forex market.
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 include: tighter dealing spreads, together with the greater availability of economic news and Forex analytics, which mean that the major currency pairs are a good way for many people to begin exploring the Forex market.
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.