If you are trading or at least reading what a beginner in Forex should know, you have encountered word Forex currency pair which represents ticket on the exchange market.
What does Forex currency pairs mean, represent and how they are used I will explain in this post.
Forex currency pair is defined by few characteristic:
- Parts of the currency pair
- Base and quote currency
- Direct and indirect quote
Parts of the Forex Currency Pair
Forex currency pair is combination of two currencies and it is combined of currency short code. Short code, mostly, is separated by slash character or nothing between them.
Short code consist of three letters and is abbreviations from complete word of that currency. For U.S. dollar short code is USD and for Euro is EUR.
Traditional currencies short code is defined by ISO standard 4217(ISO 4217). For currencies that short code is similar to some other short code in front of their code is added prefix X.
What is XAU in Forex
As an example you can take a Gold. Short name for the the GOLD is XAU where the X prefix is added in front of the chemical name.
AU in the table of chemical elements is GOLD so when you want to use GOLD in Forex you add X in front.
That way you know that XAU in Forex is for GOLD. For example if you have silver then you would have X+ AG = XAG.
Base and Quote Currency in Forex Currency Pair
Forex currency pair consist of base and quote currency. Base currency is the first currency and quote currency is the second one in currency pair. Base currency, mostly, is domestic currency, dominant currency or the most liquid currency. There is exception on USD trading pair where EUR, NZD, GBP and AUD currency is quoted as a base currency.
For further explanation I will use ETH/BTC combination so you can follow easily.
Whenever you trade pair you choose what you will do with base unit. Will you buy, sell or you will hear someone say “go long”(buy) or “go short”(sell). Whatever you do to base unit you will do opposite to quote unit. If you buy base unit you will sell quote unit in same trade.
When you see trading pair ETH/BTC on the trading platform, first currency in the trading pair is currency which you buy or sell when trade is open. To buy or sell base currency you need to have an account on exchange platform to make a trade. Before you open trade with buy or sell order you have to decide which amount to trade.
Base Unit Value in Forex Currency Pair
When opening a trade you will see what is the current price of trading pair. This information is important because it says how much base currency is worth of the quoted currency. It means how much of the quote currency you need to buy one (1) unit of base currency.
When the price of ETH/BTC trading pair is 0.034 then value od 1 ETH is worth 0.034 BTC. Pay attention that ETH/BTC = 0.034 is not same as BTC/ETH = 0.034. You cannot easily change position of base and quote unit in a trading pair because value 0.034 is not same for those two cases.
If price of the trading pair ETH/BTC drops to 0.033 the buying strength of ETH has weakened and buying strength of BTC is strengthened.
To show you closer this situation imagine this:
Yesterday you could buy 1 ETH for 0.034 BTC or in other direction you could buy 0.034 BTC for 1 ETH.
Today price of the trading pair fell to 0.033 and thus price of 1 ETH becomes cheaper. Now you can buy 1 ETH for 0.033 BTC or in other direction you can buy 0.033 BTC for 1 ETH.
Direct and Indirect Quote
Forex currency pairs can be divided into two types, direct and indirect. In direct quote base currency is foreign currency and quote currency is domestic currency.
Indirect quote is opposite to direct where base currency is domestic currency.
For trader or companies in any country easiest method is to have indirect quote because their own, domestic, currency is base currency and it is easy to calculate value when exchanging currencies. You will see that only few countries, countries close to U.K., use direct quote, as GBP, AUD, NZD and CAD.
For U.S. on exchange market it is not used USD/EUR combination but EUR/USD just because of convention.
Trading Forex Currency Pair
On the picture below you can see BTCUSD trading pair on trading platform. Current price is 6425.10 U.S.$ for 1 BTC and value is falling down since 28.09.2018. At this moment you can say that 1 BTC is worth less comparing to 2 week before when price was 6766.08 U.S.$.
When you want to start a trade this will be first information you will see. You need to decide in which direction value of base currency, BTC, will go, up or down.
If you buy base currency and price goes up then BTC value will be higher. Value of 1 BTC will worth more and you will earn money. If it goes down 1 BTC will worth less and you will lose money.
To decide in which direction it will go you can check technical analysis by looking on the chart and see previous behavior of the price.
Previous price and technical analysis can help to determine where price could go but it does not to be correct because price is volatile and many factors have impact on it. Technical analysis is topic I will cover later.
Major and Minor Forex Currency Pair
Major currencies in foreign exchange market are one which have high liquidity and which is frequently traded. In Forex market those are EUR, USD, NZD, AUD, GBP, CHF and JPY.
When talking about major Forex currency pairs, we talk about combination of major currencies. We can count several of them by combining list from the picture above.
Major Forex currency pairs are
One note you should remember is that some traders and some editors like to use shorter name for certain currency pairs.
For example GU in Forex is GBP/USD.
As you can see most currency pairs are combined with USD as quote currency because around 90% market volume is made with U.S. dollar.
Minor Forex currency pairs are the ones that do not contain U.S. dollar but contain at least one of the other major currencies like EUR, GBP, JPY.
Minor currency pair can include both of major currencies(no U.S. dollar) but it is not mandatory.
Cross-Currency Forex Pairs
Cross-currency Forex pairs or simply said “crosses” do not contain the U.S. dollar, EUR/GBP, EUR/JPY etc. If you check history you will see that if you wanted to convert currency you have had to first convert into U.S. dollar and then into the currency which you wanted.
This issue is solved with crosses and now is possible to directly convert desired currency.
If you encounter some shorter letter combination like GJ, you should know that some pairs have even shorter names.
GJ is GBP/JPY in Forex. Some traders like to shorten the name for easier writing and faster spelling.
There are other Forex pairs that do not contain major currencies, but they are widely used under different names.
One of them is CFD in Forex which is short name for contract for difference.
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