What Is a Currency Pair?
A currency pair is the quotation of two different currencies, with the value of one currency being quoted against the other. The first listed currency of a currency pair is called the base currency, and the second currency is called the quote currency.
Currency pairs compare the value of one currency to another—the base currency (or the first one) versus the second or the quote currency. It indicates how much of the quote currency is needed to purchase one unit of the base currency. Currencies are identified by an ISO currency code, or the three-letter alphabetic code they are associated with on the international market. So, for the U.S. dollar, the ISO code would be USD.
The first currency in a currency pair (the one on the left side from the slash “/ “) is called Base Currency. Base currency always has a value of 1. The second currency in the currency pair (the one on the right side from the slash “/”) is called counter currency or Quote Currency.
For example: EUR/USD
· EUR – base currency with value of 1.
· USD – quote (or counter) currency
Think of the base currency as the “root”. When you buy, for example EUR/USD, it means that you are buying the base currency (EUR) and simultaneously selling the quote currency (USD).
USDJPY, USDCHF, USDCAD, EURUSD, GBPUSD, AUDUSD, NZDUSD constitute a group of so-called “Majors” – they are united by the fact that one of the currencies in the pair is always the US dollar. This is the most highly liquid financial instruments that have a significant volatility and capacity to fluctuate substantially and, therefore, they carry a nearly inexhaustible potential for profit.
There are also other groups of instruments. If, for example, the base currency is the Australian dollar, and the quote currency is the Canadian dollar, this is AUDCAD cross-rate. The so-called cross-rates are divided into “major crosses” and “minor crosses” according to their liquidity in the financial markets.
Besides the fact that there are various groups of financial instruments, we can mention that some currencies can often play one or another typical role. In particular, the currencies of the most stable countries, as well as contracts for precious metals (USDCHF, USDJPY, XAUUSD, XAGUSD) can play the role of financial instruments, investments in which can help you safely ride out times of crisis on the markets. In trader’s jargon, such instruments are called “safe haven” (ref. “safe haven”). The currencies of those countries in whose export system raw materials prevail are often called commodity currencies (e.g.: USDCAD, AUDUSD).
Examples of a base currency
Let’s say that you are looking at the EUR/USD pair. In this example, the base currency is the euro and the quote currency is the US dollar. If the price of the EUR/USD pair is 1.3000, it means that you would need $1.30 to buy a single euro.
When you trade forex, you have the option of going long or short. This means that you will need to assess which currency in the forex pair is considered ‘weak’ or ‘strong’ when compared to the other currency.
If you open a long position, you would do so in the expectation that the base currency will rise, or that the quote currency will fall. So, if you thought that the US dollar was going to fall in value, or that the euro was going to rise, you would buy EUR/USD.
If you were to open a short position, you would do so with an expectation that the base currency will fall in value against the quote currency. So, if the US dollar is strong, you would want to execute a sell order on the EUR/USD pair.
Factors that Impact Currency Pairs
The following are several factors that affect currency pairs:
- Interest rates
- Gross Domestic Product (GDP)
- Federal Reserve actions
- Other economic announcements
- Quote currency in Forex is important to determine the base currency’s value.
- Mostly, widely used currencies like the USD, EUR, GBP, etc., are considered the counter currencies, except in cases where two countries with other currencies trade with each other.
- The counter currency can be domestic or foreign, based on the quote type, which can be either direct or indirect.
- International markets, global trade, foreign investments, currency trading, etc., depend on base and counter currency values. In turn, many domestic and international economic conditions will affect these values.