Currency Pairs: They Just Go Together
In this lesson we are going to dive into the fundamentals of how currency trades are structured. To do so, we need to take a look at Currency Pairs, the basis and fundamental element of all currency trading.
The Currency Pair
Currencies are traded in pairs. This is because a currency standing alone has no intrinsic value on the international markets.
Wait... What? How can my currency have no value? I use it to buy things all the time!
This statement may seem a bit odd, so let’s take a look at an example. Let’s say you work in an import-export business in Great Britain and you specialize in importing
horse cow meat from France.
In Great Britain, you use Pounds (GBP) to sell your meat to consumers. However, when you go to France to purchase the meat, the seller requires you to pay in Euros (EUR). So the question is, how much is 1 British Pound worth in Euros?
The answer is the current exchange rate, or the amount of Euros you get for one British pound.
In other words, the value of 1 British Pound when in France is the Pound to Euro exchange rate. Without the exchange rate, the British Pound has no value in France. Hence, currencies are always quoted in pairs: GDP/EUR, EUR/USD, USD/JPY, etc.
We will cover exchange rates in the next lesson. But before we can do so we first need take a closer look at currency pairs, how they are structured and how they work.
Reading Currency Pairs
In order to trade, you need to know how to read a currency pair.
First, you need to know your currency symbols.
Currencies are always written using 3 letters. The first two letters refer to the country where the currency is printed. The third letter refers to the name of the currency.
So, USD stands for United States Dollar. GBP stands for Great Britain Pound. AUD stands for Australian Dollars, etc.
Here is a table of the most commonly traded currencies and their acronyms:
|CHF||Swiss Franc (CH is the country code for Switzerland)|
|EUR||European Euro (the only currency that does not follow this pattern)|
|GBP||Great Britain Pound|
|NZD||New Zealand Dollar|
|USD||United States Dollar|
There are three notable additional currencies which deserve to be on this list, although they do not have a country of origin, and are not technically currencies: Gold, Silver and BitCoin.
|XAU||Gold (Index Aurum - Latin for gold)|
|XAG||Silver (Index Argentum - Latin for silver)|
|BTC||Bit Coin (Latin for bitcoin...)|
Second, currency pairs always contains two currencies: the Base Currency and the Quote Currency. The base currency refers is the first currency shown in a currency pair, and the quote currency is the second.
Lets look at an example: in the EUR/USD pair, the first currency (EUR) is the base currency. The second currency (USD) is the quote currency. In this example, the exchange rate would represent how much of the quote currency is required to buy 1 unit of the base currency.
Confused? Don’t worry, this will become clearer when we get into exchange rates. For now, you just need to understand how currency pairs are written.
Traded Currency Pairs
There are 3 types of currency pairs you need to know about: Majors, Cross Currency Pairs, and Exotics.
Although all countries must trade currencies, only a handful of currencies pairs are significantly traded. These pairs are called the Major Currency Pairs and include:
|AUD/USD||Australia / United States||"aussie dollar"|
|EUR/USD||Euro Zone / United States||"euro dollar"|
|GBP/USD||United Kingdom / Untied States||"pound dollar"|
|NZD/USD||New Zealand / United States||"kiwi dollar"|
|USD/CAD||United States / Canada||"dollar loonie"|
|USD/CHF||United States / Switzerland||"dollar swissy"|
|USD/JPY||United States / Japan||"dollar yen"|
You may have noticed that all of the Major currency pairs contain the USD as one of the pairs. In fact, over 80% of currency exchanges involve the United States Dollar. This is due to several factors:
- The USD represents 62% of reserve currencies used by banks and governments around the world.
- Commodities, such as oil, sugar, coal, etc. are traded in USD. For example, let’s say Germany wants to buy oil from Venezuela. Because oil is traded using the USD, Germany first has to buy USD before it can purchase the oil from Venezuela.
Why the USD is used for most transactions is not very relevant for this discussion, but it can basically be broken down into several factors: The United States’ role in 20t century history, the size of the US economy, the extent of US military power, and the stability of the US political system. Of course things can change and perhaps the Peso will soon take on the role the USD currently plays!
Currency pairs that do not contain the US dollar are called cross-currency pairs, or crosses. You might also hear them referred to as minors. Some of the important crosses include:
- GBP/JPY (British pound / Japanese yen)
- EUR/GBP (Euro / British pound)
- AUD/JPY (Australian dollar / Japanese yen)
- EUR/CAD (Euro / Canadian dollar)
- CAD/JPY (Canadian dollar / Japanese yen)
Cross currencies can often be more complex to trade than Major currencies due to a number of factors that will not be mentioned in this chapter. Because of this complexity, Cashout does not offer any crosses in the application.
The final category of currencies is call the exotic pairs. Exotics are composed of the USD paired with one of the less commonly traded currencies. Cashout currently offers two tradable exotics in the app:
|USD/NOK||United States / Norway|
|USD/SEK||United States / Sweden|
After reading this lesson you are one step closer to understanding currency trading. You now know how to read a currency acronyms, that currencies are traded in pairs, how currency pairs are structured, and which currency pairs you can trade.
In the next lesson we will cover exchange rates, and all that this implies.