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Forex Trading Currency Pairs – A Simple Break Down Of The Currency Pair

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Introduction

 

 

The value of a currency is always expressed in terms of another currency. These two values combine to form a currency pair.

Because currency pairs have two sides, they can be difficult to understand.

And in this lesson, you’ll learn about forex trading currency pairs – that is, what a currency pair is, how it’s constructed, and discover the most widely traded pairs. You’ll also find out why some investors are drawn to the forex market.

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Currency Pairs

 

 

Let’s start with what a currency pair represents.

A currency’s value reflects such factors as the size of a country’s economy, growth rate, interest rate levels, and fiscal and monetary policies.

These factors vary significantly from country to country – as this is why currencies are paired.

A currency pair helps equalize factors between two countries by finding a rate of exchange from one currency to another. These exchange rates are very important because they facilitate trade and promote investment between two countries.

 

 

As previously mentioned, a currency pair is simply two currencies paired together – but its also what investors actually buy and sell when investing in the foreign exchange, or forex, market.

Now that you understand what a currency pair represents and what it is, lets move on to how one is constructed.

Components Of A Currency Pair

 

 

A currency pair is constructed using a base and quote currency.

Whenever you see a currency pair, the base currency is on the left and the quote currency is on the right.

The value of a currency pair, or exchange rate, tells the value of the base currency expressed in terms of the quote currency.

 

 

Think about it like this, the exchange rate explains how many units of the quote currency it would take to equal one unit of the base currency. Let’s look at an example.

Here’s a currency pair involving the Euro and US Dollar (EUR/USD).

The Euro is the base currency and the US Dollar is the quote currency.

Let’s say that the pair is valued at $1.25. The pairs value means it takes $1.25 to equal one Euro.

 

 

The pair itself is what investors buy or sell in the forex market. Even though the pair involves two currencies, it acts as a single item like a stock, bond, or commodity.

A currency pair is priced just like stocks, bonds, and commodities, with bid and ask prices.

When buying a currency pair, you pay the “ask” price.

When selling a currency pair, you receive the “bid” price.

The difference between bid and ask prices is referred to as he bid ask spread. This spread represents the cost of investing or commission paid in a currency pair.

 

 

The bid ask spread varies quite drastically among the different currency pairs.

Pairs with the largest bid ask spreads usually have the least trading activity – while pairs with the smallest trade the most.

These active pairs are often referred to as the majors (i.e EUR/USD, GBP/USD, USD/JPY, AUD/USD, USD/CHF, ect,).

The majors are the most widely traded pairs and consequently most suitable for investors new to the forex market.

You’ve probably noticed that among the majors, sometimes the US dollar is the quote currency, like with the Euro and pound – and other times, it is the base currency like with the Swiss Franc and Yen.

Whether the US dollar is the base or quote currency, just remember that its value is always expressed in terms of the quote currency.

 

 

Take the yen for example, which lists the US dollar as the base currency and the yen as the quote currency.

Let’s say that the value of the dollar and yen currency pair is 95 yen. This means that 1 US dollar is equal to 95 yen.

Even though its expressed in terms of yen, the pairs actual value equals one unit of the base currency, which is the US dollar.

 

 

Of course, the value changes almost constantly because the forex market is operates 24 hours a day, fives days a week.

This 24 hour nature is what is one of the forex market appealing characteristics.

Let’s conclude by discussing some of the other benefits and risks of the forex market.

 

Benefits The Forex Market Has To Offer

 

 

Investors worldwide buy and sell currency pairs, changing values all day and night. These value changes are how investors make a profit or loss in the forex market.

If an investor buys a pair and it increases in value, the investor profits.

 

 

Conversely, if the pair drops, the investor will suffer a loss.

The forex market offers unique benefits – but it also has it’s risks.

These include the risks of using too much leverage, or sudden changes in values of pairs that can result from news events.

 

 

Its important to understand these risks before investing in the currency pairs that you’ve learned about in this lesson, or any other investment related to the forex market.

 

 

Quick Recap

Forex Currency Pairs

 

  • A currency’s value reflects such factors as the size of a country’s economy, growth rate, interest rate levels, and fiscal and monetary policies
  • A currency pair helps equalize factors between two countries by finding a rate of exchange from one currency to another. These exchange rates are very important because they facilitate trade and promote investment between two countries
  • As previously mentioned, a currency pair is simply two currencies paired together – but its also what investors actually buy and sell when investing in the foreign exchange, or forex, market
  • The pair itself is what investors buy or sell in the forex market. Even though the pair involves two currencies, it acts as a single item like a stock, bond, or commodity

 

A Currency Pair Consists Of TWO Parts: The Base Currency & The Quotes Currency

 

  • The base currency is on the left of the currency pair
  • The quote currency is on the right of the currency pair
  • The VALUE of a currency pair is EXPRESSED IN TERMS OF THE QUOTE CURRENCY
  • I.E If the USD/JPY is valued at 97.235 for example, the USD (US Dollar) is the base currency, the JPY (Japanese Yen) is the quote currency, and 1 US Dollar = 97.235 Japanese Yen

 

Currency Pair Spreads

 

  • A currency pair is priced just like stocks, bonds, and commodities, with bid and ask prices
  • When buying a currency pair, you pay the “ask” price
  • When selling a currency pair, you receive the “bid” price
  • The difference between bid and ask prices is referred to as he bid ask spread. This spread represents the cost of investing or commission paid in a currency pair
  • The bid ask spread varies quite drastically among the different currency pairs
  • Pairs with the largest bid ask spreads usually have the least trading activity – while pairs with the smallest trade the most
  • These active pairs are often referred to as the majors (i.e EUR/USD, GBP/USD, USD/JPY, AUD/USD, USD/CHF, ect,)
  • The majors are the most widely traded pairs and consequently most suitable for investors new to the forex market

 

Common Perks of The Forex Market

 

  • The forex market is operates 24 hours a day, fives days a week
  • Investors worldwide buy and sell currency pairs, changing values all day and night. These value changes are how investors make a profit or loss in the forex market
  • If an investor buys a pair and it increases in value, the investor profits
  • Conversely, if the pair drops, the investor will suffer a loss
  • The forex market offers unique benefits – but it also has it’s risks.
    These include the risks of using too much leverage, or sudden changes in values of pairs that can result from news events

 

 

 

 

These are crucial things that one must know if you are considering trading or investing in forex.

Currency pairs, as I have already stated above, consist of the base, the currency on the left and the quote, the currency on the right. The numerical value that you see when you pull up a stock chart is expressed in what is known as “Pips” (Percentage In Point). It should also be noted that the numerical value shows you what one currency unit of the base is, in terms of the quote (always read from left to right).

While there are many currency pairs that you can choose from, currency pairs are divided into two distinct categories, major and minor pairs.

Major pairs are well-known currency pairs (i.e EUR/USD, USD/JPY. AUD/USD, GBP/USD, ect.) – and typically have the smallest bid-ask spreads with greater trading volume. Minor on the other hand, are some of the least popular currency pairs (NZD/JPY, GBP/CAD, CHF/JPY, EUR/USD, ect.) – and typically have the largest bid-ask spreads with fewer trading volume.

Forex, as you will have already noticed, is open 24 hrs per day – 5 days a week – which is a perk that allows traders to see the aftereffects of the world markets. They also have high amounts of liquidity, volatility, and leverage – all factors that can go all of two ways, if not invested wisely.

But as always, forex trading, like all derivative day trading, is extremely risky. This should only be used by advanced and sophisticated traders who have years of experience and expertise.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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