What Is a Currency Pair?All Forex entails exchanging one currency for another and therefore each Forex quote involves a pair of currencies. When you buy a bag of apples, you pay a specific sum of money for the bag, but when you buy a “bag” of a foreign currency, you are still paying a specific sum of money but the thing you are buying is also money. The price of the bag of foreign money is quoted as a ratio of the money you are paying, or an exchange rate.The euro exchange rate versus the US dollar might be say, $1.3500. This means for 1 euro you receive 1.35 US dollars. The yen exchange rate versus the dollar might be ¥105.00. This means for 1 US dollar you receive 105 yen.The euro versus the dollar is a pair and the dollar versus the Japanese yen is another pair.A pair does not need to be dollar based. The euro versus yen is also a pair, as would be UK pound sterling versus yen. Every single currency quote you see should name the two currencies in the pair. It you see just “euro,” you can assume the other half of the pair is the US dollar, although sometimes it pays to make sure that you are talking about the same pair as your counterparty.Memorize the Three-Letter AbbreviationsYou need to memorize the three-letter abbreviation for each currency that populates your workspace when you trade Forex.They are relatively easy to memorize since they usually refer directly to the first letter of the name in English, like United States dollar (USD). As a general rule, the first two letters name the country and the last letter names the currency.Having memorized them will be useful if you ever start to trade cross-rates. Exceptions include the South African Rand, which starts with a Z instead of an S (from Dutch Zuid-Afrikaanse Rand). Sometimes you can deduce logically what an exchange rate abbreviation should be (like NZD for New Zealand dollar), but other times you just have to look up the symbol (TRY for Turkish lira and KRW for South Korean won). You might think the Swiss franc would be SWF, but it is not — it is CHF, the CH standing for the name of Switzerland in Latin, Confoederatio Helvetica.USD = US dollarGBP = Great Britain poundEUR = EuroCHF = Swiss francJPY = Japanese yenCAD = Canadian dollarAUD = Australian dollarNZD = New Zealand dollarZAR = South African randWhat Are the Most Commonly Traded Currency Pairs?According to the Bank for International Settlement’s latest Triennial Central Bank Survey conducted in April 2016, the dollar, the euro and the yen constituted the lion’s share of all spot transactions.We will discuss spot versus forward and futures trading in Trading Forex via Futures.Of the $5.34 trillion traded in the currency market each day, $2 trillion was done in spot. Of that $2 trillion, $1.69 trillion was in dollars, $754 billion was in euros and $612 billion was in yen.This makes euro-US dollar (EUR/USD) and US dollar-yen (USD/JPY) the most commonly traded currency pairs.The next two currencies, in terms of size traded in the spot market, are sterling at $227 billion daily and the Australian dollar at $196 billion. Sterling versus US dollar (GBP/USD) and Aussie versus US dollar (AUD/USD) are the next most commonly traded currency pairs.Cross Rate PairsAs mentioned in the first lesson, cross rates have evolved to indicate a currency pair that has no US dollar component.Euro-yen (EUR/JPY), sterling-yen (GBP/JPY), euro-Aussie (EUR/AUD), Aussie-Canada (AUD/CAD), Korean won-yen (KRW/JPY), etc. are all examples of cross rate pairs.Because cross rates are less frequently traded, prices are often more volatile and have wider bid-ask spreads. Euro-yen is an exception to this rule, with a deep and liquid market.Trading LingoIt is important to know some lingo, or the special vocabulary used in the forex market. The most prominent nickname is cable, meaning the UK pound. The word cable refers to the transatlantic telegraph cable laid in 1858. At that time, the UK pound was the top currency for US traders and so to ask for a price in UK pounds, they would ask for the price of cable. At the time, traders who made the prices were called cable dealers and even today, the person trading sterling at a bank is called the cable dealer.The New Zealand dollar is called kiwi, for the kiwi bird that New Zealand is famous for and the Canadian dollar is called the loonie, because there is a picture of a loon (Canada’s national bird) on the back of the Canadian one-dollar coin.Traders ask for a price in cable and know that this means a price for UK pound sterling versus the US dollar. Similarly, a price in kiwi or the loonie would mean the price at which someone would buy or sell the New Zealand or Canadian dollars versus the US dollar.The Norwegian krone is called the Nocky and the Swedish krone Stocky. Asking for a price in Nocky or Stocky would get you the price where someone would buy/sell US dollars versus the Norwegian krone or Swedish Krone. If you wanted a price in euro versus the Norwegian krone, you would ask for euro-Nocky. The Mexican peso would be Mex and the Hungarian forint Huf.The language of foreign exchange is no different from other languages; there are rules and then exceptions to the rules. Rather than ask for a price for the euro versus the US dollar, a trader will simply ask for a “euro” price. Similarly, an Aussie price would be a price of the Australian dollar versus the US dollar.To complicate matters further, FX convention quotes most currency pairs in dollar terms. A trader will ask for dollar-yen when wanting the price of the US dollar versus the Japanese yen, or dollar-rand, when asking for the price of a US dollar versus the South African rand.
What Is Forex?“Forex” is the abbreviation most used today for “foreign exchange,” meaning the price of one currency in terms of another currency. By definition, all Forex prices refer to the relationship between two currencies, i.e., a pair of currencies.The term “Forex” is used interchangeably with the term “FX.” Both are used today and both refer to the same thing, foreign exchange. The term “FX” is mostly used in the US while “Forex” was more broadly used in the UK until recently. Professional traders in the US at banks and brokers tend to use the term “FX” while “Forex” is the term used in the retail market, adopted from the British usage. Also used is the word “currency,” as in “I trade currencies” or “something happened in the currency market.”Foreign exchange refers literally to money, or more accurately, to money in two different denominations. The “exchange” part of the term means giving one thing of monetary value in return for a different thing of equivalent value. The word exchange refers to the transaction in which each of two parties is willing to exchange his respective basket of money for the equivalent amount of money denominated in the second currency. The price at which the two parties are willing to make the exchange is the exchange rate.The price of one currency in terms of another currency is called a “rate” and not a “price,” although the word “price” is equally valid and often used. Foreign exchange is the only market in which the word rate is used in place of the word price. The reason for this usage is probably due to the word “rate” being used since the Middle Ages to refer to a tariff or tax levy, since converting one currency to another entails applying a ratio or a proportion to one currency relative to the other. A common Latin phrase is “pro rata” from “pro rata parte,” meaning “in proportion.” The word “rate” in English comes from the Latin “rata.”What Is Being Exchanged?Since foreign exchange refers to two baskets of money, each with its own denomination, a foreign exchange transaction can be as simple as buying a basket of 165 dollars in return for £100 at an airport kiosk. The exchange rate is $1.65 per UK pound sterling.Why is the exchange rate not £0.6061 per dollar? This the same exchange rate, just expressed differently (it is the reciprocal, or 1 divided by 1.65). The answer lies in the historical convention of quoting the price of other currencies in terms of what they cost in pounds. The pound sterling was the benchmark currency for centuries until just after World War II, meaning the central currency against which all other currencies were judged and priced.After World War II, the US dollar became the benchmark currency and most other currencies were priced in terms of how many units of the foreign currency you could get for one dollar.As a rule, any money not issued by your home government is “foreign.” The natural way to look at foreign exchange is to ask: “How many units of the foreign currency can I get for a fixed amount of my home currency?” This is how a tourist or an importer looks at foreign exchange. But because the dollar is currently the benchmark currency against which almost all others are priced, the dollar comes first in the name of many currency pairs, although not all. The first name in a currency pair is generally the important name and the second is the secondary or less important one.Putting a name first is to assume that the fixed amount is denominated in that currency and the variable amount will be the other currency. In other words, the first currency is the base and you are applying a ratio to derive the price of second currency. When the European Monetary Union decided to quote the euro in the format “Euro/USD” and “Euro/JPY,” etc. it was a deliberate choice to make the euro the more important of the two currencies in every pair.The rule is that whichever name comes first is the one that is getting stronger on higher numbers and weaker on lower numbers. If the number goes up in the pound, for example, from 1.6000 to 1.6500, it means the pound is getting stronger and by definition, the dollar is getting weaker because in this pair, the full quote should read GBP/USD. It is accurate to express the quote as $1.6000 to $1.6500, meaning the pound used to cost $1.6000 but now it costs $1.6500. Journalists usually apply the convention of putting the dollar sign in front of the price quote, although brokers and analysts tend not to insert the currency symbol.This is also true of the euro (EUR/USD) so a higher number always means the euro is getting stronger vis-à-vis the dollar. You could say the EUR/USD moved from 1.3200 to 1.3900, meaning it got more expensive in dollar terms. If you are new to Forex, you can place an imaginary currency symbol in front to the first-named currency to get your bearings. Therefore, the price quote now looks like $1.3200 to $1.3900.The pound, euro, Australian dollar, and New Zealand dollar are the top key currencies in which the dollar does not come first, because of historic convention. All other currencies are quoted in terms of dollars, such as USD/CHF = US dollar against the Swiss franc.Below is the Yahoo! Finance’s list of major currencies. Yahoo! Finance is one of many providers of market information in the professional and retail Forex market. Other providers, including brokers, have their own version of this list.Major currency pairs by Yahoo! FinanceCross-ratesA few decades ago, a cross-rate was any currency pair that did not include your home currency. The US dollar/Japanese yen exchange rate would be a cross-rate for someone in the UK or Europe, for example.Today, however, the common definition of a cross-rate is any currency pair that does not include the dollar. Therefore, the USD/JPY exchange rate is a “major” exchange rate and not seen as a cross-rate by people in the UK or Europe, while the AUD/CAD would be seen as a cross-rate by everyone, including Australians and Canadians, even though the rate includes their home currencies.This convention for defining a cross-rate is not accepted everywhere and you will see lists in newspapers and websites that define cross-rates differently. The US dollar accounts for about 70% of global government money reserves and 70% of world trade, so placing the dollar as a component in all the major exchange rates is not without justification. In fact, there are more dollars in banknotes and bank deposit accounts outside the US than inside the US, so it may be accurate to say the dollar is the most-used currency in some places even though it is not the home currency. However, when someone says "the euro," he is always talking about EUR/USD and never talking about EUR/GBP, in which case the second currency must be named.See the list of Yahoo! Finance's European cross-rates. This is a typical list for European countries:Cross-rates by Yahoo! FinanceEvolving PracticesYahoo!, one of the top news and data providers, chooses to include non-dollar crosses as “major world currencies.” As a practical matter, if you are trading euro/dollar, you can say “euro” without the word “dollar” and you will be understood. If what you really mean is “euro/yen”, though, you must say the name of the second currency.TradingWhen you go to the airport kiosk to exchange your home currency for another one, you are not trading. You are a price-taker. The kiosk sign tells you what exchange rate will be applied and you are stuck with it. You can take it or leave it.This is not trading. Trading is the process of going back and forth with the opposing party until you discover the price that makes each of you the least unhappy. Trading involves negotiating a price that satisfies both parties and can involve game-playing, deceit, and other tricks. You may be bidding on something the other person thinks is more valuable than you do, or you may be offering something you value more highly than other people out there who want to buy. When the final price is reached and both parties have agreed upon it, the result is a contract, whether by handshake or formal paperwork, that you will deliver your basket of currency to the other party and he will deliver his basket of his currency to you at some specified place and time. As a rule, in practice the actual exchange is a wire transfer from one checking account to another in the two countries of issuance of each currency.