Forex, derived from ‘foreign exchange’, in the most basic sense, is simply the process of exchanging one currency for another. A Forex trader will buy a currency at the current market price and sell it again at a target price in the future. Because currency prices are always changing, the purchase and the sale price will be different, and the difference between the two prices will be the trader’s profit or loss.
Currency Pairs
In Forex trading, the asset is always a set of two currencies called a currency pair. Currencies are quoted in pairs because the two currencies in a pair are bought and sold simultaneously. An example pair is the EUR/USD (euro/US dollar).
The first currency of any pair is called the base currency, and the second currency is called the quote currency. In the EUR/USD, the euro is the base currency, and the US dollar is the quote currency.
There are three categories of currency pairs: major, minor, and exotic pairs.
Major Currency Pairs
The major currency pairs are the world’s most important currencies based on the volume traded. The EUR/USD, GBP/USD, USD/JPY, USD/CAD, and AUD/USD pairs are some of the major currency pairs. They represent the most important economies in the world.
The more trading volume a currency pair has, the more liquidity there will be. In other words, the more traders trading the currency pair on the market, the easier it will be to buy and sell that currency pair. With higher liquidity also comes lower transaction costs.
Minor Currency Pairs
All Forex major pairs include the US dollar. If you pair two major trading currencies but neither of the two are US dollars, it is a minor currency pair. Examples of minor currency pairs are EUR/GBP, EUR/JPY, GBP/JPY, AUD/CAD, and GBP/CAD.
Exotic Currency Pairs
Exotic currencies are currencies that are not widely used in global financial transactions. An exotic currency pair is the pairing of a developing economy’s currency with a major currency. The developing economy’s currency can either be the base or the quote in the trade. Usually only very experienced Forex traders venture into the world of trading exotic currencies as the values of exotic currencies are usually very unpredictable and unstable. They are especially vulnerable to influences from factors like political or economic aspects of a country, which can trigger extreme movements or swings within the exotic trading pairs.
Examples of exotic currencies are the Norwegian Krone (NOK), Polish Zloty (PLN), and Indian Rupee (INR).
Factors That Influence Currency Exchange Rates
Currency prices are set by supply and demand. But the constant shifts in supply and demand of the dozens of frequently traded currencies makes the Forex market very complex and unpredictable. However, there are indicators that Forex traders can use to help them predict price movement.
Central bank economic policy
National economic policy, set by central banks such as the Bank of England in the UK or the Federal Reserve in the USA, affects currency prices. Many factors are involved here, for example, an increase of money in circulation and interest rates. Changes in economic policy can create major fluctuations in currency value.
Current events
Current events also play a major role in the price of a currency. This effect can be observed anywhere in the world. Events like political instability/stabilisation, fluctuations in a country’s economy, unrest or warfare, major changes in the government, etc. can all impact the currency price. As a rule, the better health a country’s economy is in, the stronger and more stable its currency will be.
In Conclusion
Understanding the different types of currency pairs and the factors that influence exchange rates, are important fundamentals of Forex trading. Together with a good strategy and proper risk management, understanding currency pairs will help you make informed decisions.
OTS News on Social Media