The trading of currency takes place on the foreign exchange market, which is the largest and most liquid in the world. Open 24 hours a day, five days a week, it sees a daily trading volume of around $6 trillion. In this article, we’ll explain more about investing in foreign exchange, and guide you through the most commonly invested forex pairs.
Forex trading explained
First of all, let us address what is forex trading? Forex is a shortened version of the term foreign exchange, and in its simplest form, is the trading of one currency against another. When investing in forex, the aim is to profit from the difference in exchange rates, as well as the fluctuations of prices in the market.
Forex trading usually takes place on the over-the-counter market, through a network of online brokers, but can also be traded through future contracts and contracts for difference (CFDs). The movement in prices can be attributed to a number of fundamental factors, such as the economic growth of a nation, the flow or turmoil of international trade, as well as the announcements and changes in interest rates.
Choosing a currency pair
The common consensus amongst traders when it comes to forex trading is to trade in your domestic currency, as this is what you’re most familiar with. This also means that you’re more likely to know the current affairs of your own country, which can impact the value of the currency.
The forex market uses International Organization for Standardization (IOS) codes to identify the currencies around the world. For example, the US Dollar is recognized by the code name USD and Euros are known as EUR.
The currencies are formed together into pairs, comparing the value of one against the other. These are known as the Base and Quote currency. The Base currency refers to the first currency, in which the investor buys. Whereas the Quote is the second currency and is the rate at which they are sold. For example, the forex pair of EUR/USD means that you are buying in Euros whilst selling in Dollars.
Currency pairs tend to come in four main categories:
Crosses and Minors are currency pairs that do not involve the USD, but still include one of the other Majors, such as the EUR or the British Pound (GBP), against one of the other smaller traded currencies. The most common Cross pair is, understandably, the EUR/GDP. Others in this category included the Euro to Japanese Yen (EUR/JPY) and the Australian and New Zealand Dollar (AUD/NZD).
Exotics refer to pairs that involve a major currency against a less liquid currency from a smaller economy. For example, the Euro to Turkish Lira (EUR/TRY) or the US Dollar to Mexican Peso (USD/MXN).
The final category is Majors, which are the most popularly traded currency pairs.
Major forex pairs
All major currency pairs are priced against the USD, which is commonly regarded as the world’s official Base currency. These currency pairs, as previously mentioned are known as Majors, and make up 80% of the total forex trading globally.
There are eight currency pairs that are classed as Majors in the forex market, but here we will go into more detail about the top three:
This forex pair is the most traded in the world, mainly due to the fact that they are relative to the biggest global economies. Because of this, and the market sentiment surrounding the pair, it has the highest volume of trade and the most liquidity.
In general, as the most traded forex pair, it experiences little volatility. But just as their vast economies make them the most popular currencies, this also means they’re a lot more fundamental factors and conditions that could affect the pair’s volatile nature.
The second highest Major in terms of the trading volume involves the USD as the Base currency against the JPY. This volume can be accredited to the huge size of Japan’s economy, as well as its core value in global trade. The location of the country also can be used as an indicator for the rest of the economic and geopolitical conditions of the wider Asian region. The JPY can sometimes be seen as a ‘safe’ investment, especially during uncertainty in the economy of other nations. However, it can sometimes be affected by fundamental factors influenced by China and Korea, due to its close connection to wider Eastern Asia.
The next most popular currency pair again includes juggernauts in terms of world economies. This currency pairing, however, tends to be more volatile than the EUR/USD, especially with recent political turmoil in the US and the effects of Brexit. This pairing has coined the nickname of Cable as it was the first currency pair to be traded via telephone lines across the Atlantic.