Chapter 3: What is Traded in Forex?

Chapter 3: What is Traded in Forex?

Introduction

When you trade forex, you’re not buying a physical product like gold or shares in a company. Instead, you’re simultaneously buying one currency and selling another. This chapter explains the fundamental units of the forex market—currency pairs—and how they work.

Currency Pairs: The Building Blocks of Forex

In forex trading, currencies are always quoted in pairs. A currency pairTwo currencies quoted together, showing the relative value of one against the other (e.g., EUR/USD). represents the exchange rate between two currencies—the price of one currency expressed in terms of another.

For example, in the EUR/USD currency pairTwo currencies quoted together, showing the relative value of one against the other (e.g., EUR/USD).:

• The first currency (EUR) is called the base currencyThe first currency listed in a currency pair (e.g., in EUR/USD, EUR is the base currency).
• The second currency (USD) is called the quote currency or counter currency
• The exchange rate shows how much of the quote currency is needed to buy one unit of the base currencyThe first currency listed in a currency pair (e.g., in EUR/USD, EUR is the base currency).

So if EUR/USD is quoted at 1.2000, it means 1 euro can be exchanged for 1.20 U.S. dollars.

Reading Currency Pair Quotes

Let’s break down how to read a currency pairTwo currencies quoted together, showing the relative value of one against the other (e.g., EUR/USD). quote:

Example: USD/JPY = 110.50

This means:

• 1 U.S. dollar (base currencyThe first currency listed in a currency pair (e.g., in EUR/USD, EUR is the base currency).) = 110.50 Japanese yen (quote currency)
• To buy 1 U.S. dollar, you need 110.50 Japanese yen
• If the rate increases to 111.50, the dollar has strengthened against the yen
• If the rate decreases to 109.50, the dollar has weakened against the yen

Types of Currency Pairs

Currency pairs are typically categorized into three groups:

1. Major Currency Pairs

These pairs include the U.S. dollar paired with other major currencies. They are the most traded and typically have the lowest spreads (the difference between buying and selling prices).

Major pairs include:

• EUR/USD (Euro/U.S. Dollar) – “Euro”
• USD/JPY (U.S. Dollar/Japanese Yen) – “Dollar Yen”
• GBP/USD (British Pound/U.S. Dollar) – “Cable”
• USD/CHF (U.S. Dollar/Swiss Franc) – “Swissy”
• AUD/USD (Australian Dollar/U.S. Dollar) – “Aussie”
• USD/CAD (U.S. Dollar/Canadian Dollar) – “Loonie”
• NZD/USD (New Zealand Dollar/U.S. Dollar) – “Kiwi”

2. Minor Currency Pairs (Cross Pairs)

These pairs do not include the U.S. dollar but involve other major currencies. Examples include:

• EUR/GBP (Euro/British Pound)
• EUR/JPY (Euro/Japanese Yen)
• GBP/JPY (British Pound/Japanese Yen)
• EUR/CHF (Euro/Swiss Franc)
• EUR/AUD (Euro/Australian Dollar)

3. Exotic Currency Pairs

These pairs consist of a major currency paired with the currency of a developing or smaller economy. Examples include:

• USD/TRY (U.S. Dollar/Turkish Lira)
• USD/MXN (U.S. Dollar/Mexican Peso)
• EUR/PLN (Euro/Polish Zloty)
• USD/ZAR (U.S. Dollar/South African Rand)

Characteristics of Different Currency Pairs

Base and Quote Currency Conventions

While there are no official rules for which currency serves as the base in a pair, market conventions have developed over time:

1. EUR is always the base currencyThe first currency listed in a currency pair (e.g., in EUR/USD, EUR is the base currency). against all other currencies (EUR/USD, EUR/GBP, etc.)
2. GBP is the base currencyThe first currency listed in a currency pair (e.g., in EUR/USD, EUR is the base currency). against all others except EUR (GBP/USD, GBP/JPY, etc.)
3. AUD is the base currencyThe first currency listed in a currency pair (e.g., in EUR/USD, EUR is the base currency). against all others except EUR and GBP
4. USD is the base currencyThe first currency listed in a currency pair (e.g., in EUR/USD, EUR is the base currency). against many currencies (USD/JPY, USD/CAD, etc.) but not against EUR, GBP, AUD, or NZD

Direct vs. Indirect Quotes

The way currency pairs are quoted can be classified as:

• Direct Quote: The domestic currency is the quote currency (e.g., for a U.S. trader, EUR/USD is a direct quote)
• Indirect Quote: The domestic currency is the base currencyThe first currency listed in a currency pair (e.g., in EUR/USD, EUR is the base currency). (e.g., for a U.S. trader, USD/JPY is an indirect quote)

The perspective depends on your location and which currency you consider “domestic.”

Currency Pair Correlations

Currency pairs often move in relation to each other due to economic and geographic relationships:

1. Positive Correlation: Pairs move in the same direction (e.g., EUR/USD and GBP/USD often move similarly)
2. Negative Correlation: Pairs move in opposite directions (e.To save on context only part of this file has been shown to you. You should retry this tool after you have searched inside the file with grep -n in order to find the line numbers of what you are looking for.