When trading forex, the trader will buy one currency by selling a second currency. Predictions concerning the pair’s future value will entice the trader to either buy or sell the first currency using the second currency; a process referred to as either going long or going short respectively. The trader’s own forecasts will direct their subsequent actions. If the Base Currency; the first currency shown within the pair; is expected to increase in value relative to the Quote Currency; the second currency shown within the pair; then the price will rise. Conversely, if the Base Currency is expected to decrease in value relative to the Quote Currency, then the price will fall. Once the trader has developed their forecasts for subsequent price movements, a position can be opened with the intention of deriving a profit from changes in the pair’s value.
Movements in exchange rates are driven by the buy and sell decisions of traders on a global scale. Resulting from their own individual analyses of the factors influencing a given currency pair’s value, these decisions aggregated create the levels of volatility which make the forex market attractive. Driven in part by fundamental analysis; that is, analysis of the economic events influencing a pair’s attractiveness; and in other by technical analysis; that is, analysis of pricing charts; foreign exchange traders must be aware of both the external influences on a pair and the influences of such concepts as pricing patterns.
To profit from movements in a pair, the trader must act in a manner that is inkeeping with their forecasts for subsequent movements. For example; where the FX trader expects the Base Currency to strengthen relative to the Quote Currency, he would buy; or go long; the currency pair to which the forecast relates. This is because the price of the currency will rise, therefore creating a profit for the trader when he closes the position by selling the pair at some stage in the future. Conversely, where the FX trader expects the Base Currency to weaken relative to the Quote Currency, he would sell; or go short; the currency pair to which the forecast relates. This is because the price of the currency will fall, therefore creating a profit for the trader when he closes the position by buying the pair back at some stage in the future.
Choosing a Currency Pair to Trade
Currency pairs are typically considered in two separate categories; these being the Major Currency Pairs and Exotic Currency Pairs. Derived from the volume of trades therein, these two categories cover both frequently traded currency pairs and less frequently traded currency pairs respectively.
The Major Currency Pairs are comprised of those currencies which are considered most significant with the Global markets; specifically, the US dollar (USD); the euro (EUR); pound sterling (GBP); the Swiss franc (CHF); the Japanese yen (JPY); the Canadian dollar (CAD); the Australian dollar (AUD); and the New Zealand dollar (NZD). The volume of trades in pairs comprising two of the currencies previously identified is such that the Major Currency Pairs are typically the most liquid; a factor which tends to attract further interest from traders keen to exploit the volatility typically associated with these pairs. It should be noted that a pair is typically only considered a Major Currency Pair when it is crossed with the US dollar. Where a pair comprises two other major currencies; for example, GBPCHF; this is commonly referred to as a Currency Cross.
Unlike the Major Currency Pairs, Exotic Pairs comprise those pairs which are typically far less liquid; a result of smaller trading volumes therein. In addition to diminished liquidity, spreads in these currencies tend to be higher than those charged for the Major Currency Pairs. Examples include the Swedish krone (SEK); the Norwegian krone (NOK); the Danish krone (DKK); the Hong Kong dollar (HKD); the South African rand (ZAR); the Thai bhat (THB); the Singapore dollar (SGD); and the Mexican peso (MXN).
