Currency Pairs Types
Economies around the world have different currencies that reflect the way an economy is doing. Stronger economies are associated with stronger currencies and a weaker currency is usually the result of an economy that performs poorly. Directly buying or selling a currency is not possible, as this can be done only against other currency. For that reason, currencies are paired in two, and Forex trading means buying or selling a currency pair. If the currency pair goes in the right direction, a profit is made. If not, the trading account suffers a loss. Currency pairs are of different types, based on the currencies in their componence. Therefore, a currency pair reflects the differences between the two economies they represent. Let’s take for example the GBPUSD pair. The two currencies that form this pair are the GBP (Great Britain Pound) and the U.S. Dollar. They represent two of the largest economies in the world: the United Kingdom and the United States economies. Having said that, it means that the currency pair is moving based on the differences between the United States and the United Kingdom economies. In other words, if the U.S. economy performs better over a specific period of time, like a quarter or a year, the GBPUSD should normally move to the downside. Shorting the pair based on the differences between the two economies it represents means trading on fundamental reasons. Fundamental analysis is not the only one that makes a currency pair moving, so it is not enough to only look at economic differences between the two economies. Other factors like technical analysis, supply and demand, etc., are also influencing currency pairs.
Different Currency Pairs
There are different currency pairs that form the so-called dashboard, and they are grouped in different categories. The one factor that matters the most in grouping currency pairs is the all-important U.S. dollar. The U.S. dollar is the world’s reserve currency, and it represents the one currency the entire financial system as we know it functions. Everything in the financial system is based on the dollar and therefore it represents the one element that allows currency pairs to be grouped.
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Currency Pairs That Have the U.S. Dollar in Their Componence
All the currency pairs that have the U.S. dollar in their componence are being called majors. A major pair is considered more important than other currency pairs for multiple reasons. One of the reasons is the fact that major pairs are more liquid. A liquid currency pair is one that is traded heavily and there are no shortages of neither supply nor demand at any one moment of time. If you think of the fact that the U.S. dollar is present in these pairs and the fact that it is the world’s reserve currency, it is only normal that these pairs are the most liquid ones. Clearings are being made in dollars and therefore volatility on major pairs is higher than on other currency pairs. Such major pairs are the EURUSD, GBPUSD, AUDUSD, USDJPY, USDCHF, USDCAD, NZDUSD. If you look at the economies these pairs represent, you’ll find the Eurozone, United Kingdom, Australian, Japanese, Swiss, Canadian and New Zealand economies. In other words, all the major economies in the world are paired with the United States economy because of the central role of the U.S. dollar. Out of the currency pairs listed above, the EURUSD is the most liquid one and the most popular one among retail Forex traders. Because of that, the spread (the difference between the ask and bid price) on the EURUSD pair is the smallest one of them all majors. In some cases, brokers offer the EURUSD pair at 0.1 pips spread, which is virtually almost no spread at all. However, not all major currency pairs are having the same liquidity. At the opposite pole, the USDCAD is the least liquid major currency pair. This means that at times, there is difficult to sell or buy the USDCAD pair in large volumes because simply there is not enough demand or offer on the pair. To counter this, Forex brokers increase the spread for the pair during this times. The time of the trading day when there is little liquidity is between the North American session and the start of the Asian one. That is the moment when the daily candle is changing on most of the Forex brokers and spreads are extremely wide.
Currency Pairs That Do Not Have the U.S. Dollar in Their Componence
Any other currency pair that is not having the U.S. dollar in its componence is called a “cross” pair. Crosses are characterized by ranging more than a major pair and this is because of the fact that the U.S. dollar is missing, hence the liquidity is low. Low liquidity brings in turn low volatility levels, and low volatility levels bring ranges. Ranges are not necessarily a bad thing for the Forex market because there are trading strategies that are made exactly for currency pairs that range the most. Such strategies involve buying or selling a currency pair based on the moves an oscillator (a technical indicator that uses a mathematical formula to plot values on the bottom of a chart, based on price levels that happened in the past) is making. An oscillator is showing overbought and oversold levels and traders are selling in overbought and buying in oversold areas. This strategy works on crosses and on trading sessions characterized by low volatility. The Asian session is typically a slow one, where ranges are dominant, so, trading a cross with an oscillator during the Asian session has more chances to be a successful strategy than on other sessions. Because of frequent periods with low liquidity, the spreads on the crosses are bigger than on majors. In some cases, the spreads are so big that it is virtually impossible to trade those crosses on a short-term horizon. The only way to trade them is to have a medium to long-term analysis and expectations. This way, the high cost of entering and exiting a trade is diminished.
Some brokers are dividing the Forex currency pairs into even more categories, like “exotic” currency pairs, “minor” currency pair, etc. What is important is to remember that these are only secondary categories and that the right interpretation is the one based on the U.S. dollar. Dividing the currency pairs based on the U.S. dollar’s role is helping traders understand what matters the most for the Forex market. If one is looking for hundreds and hundreds of pips in a trade, it is unlikely that this kind of a move is going to happen on crosses. Keeping a realistic approach is healthy for a trading account. Knowing the advantages and disadvantages of trading crosses is helping traders staying profitable over the long run.
Recommended Further Readings
- Forex Trading – Explaining the Concept
– What is forex trading, generalities about trading the currency market.
- Why Trading Forex?
– Advantages and disadvantages of trading the currency market, what are trader’s expectations and what is a realistic approach to follow
- What is a Forex Broker and Types of Brokerage houses
– Explaining what a Forex broker is and does, how the business should be organized, and how many types of Forex brokers exist.
- Financial Products to Trade
– Different categories of financial products that a Forex Broker is offering for the retail clients, starting with the classical currency pairs, and continuing with commodities, CFD’s, indexes, etc.
- Forex Trading Sessions and Their Importance
– Explaining the differences between the three Forex trading sessions, what are their importance, ranking, etc.
- Forex Brokers Types – ECN or STP?
– What is ECN, STP, how d- brokers deal with client’s orders, advantages, and disadvantages of the tw- types.
- “Stochastic skew in currency options.” Carr, Peter, and Liuren Wu. Journal of Financial Economics 86, no. 1 (2007): 213-247.
- tochastic risk premiums, stochastic skewness in currency options, and stochastic discount factors in international economies. Bakshi, G., Carr, P., & Wu, L. (2008). S Journal of Financial Economics, 87(1), 132-156.