The currency pair is the foundation of foreign exchange trading or what is more popularly known as forex. As most of you may already know, forex trading is the exchange of currencies. It basically takes advantage of the continuous movements of currency rates everyday. It is important that before you venture into forex, you have a basic understanding on how to read a currency pair.
What is currency? It is a country’s accepted form of money. It is a medium of exchange and the basis for trade of every country. There are also currencies that are only available in certain local communities or in relation to certain products like games or airline credit points.
To know how to read a currency pair, you would have to focus on knowing currencies from different countries. Each country has it own form of currency. For example, Switzerland has Swiss franc as their official currency and the US has US dollars for theirs. You can usually find currency or money in the form of either coin or paper notes. This currency is used to pay for goods and services offered in the community.
Many people, particularly investors, would often trade currencies in the forex market. You would be surprise how a large amount of currencies are being traded each day. In fact, forex is considered as one of the most heavily traded markets in the world.
To exchange currencies, an exchange rate was set in order to know the relative value of one currency to another. These rates changes every minute in relation to the changes in the market. These rates are what most called to be floating.
Most major currencies like the US dollar and euro can be converted to another currency in the money market. You probably had experienced trading one currency to another in a bank or currency exchange windows. These currencies are called convertible currencies. This means that these currencies are used in the forex trading and are allowed to be converted to its equivalent relative value.
So what is a currency pair? It is a quotation that shows the relative value of one currency to another. These currencies are written using their abbreviations prescribed by the International Organization for Standardization (ISO) in standard ISO 4217. Being familiar with currency abbreviations is important if you want to start knowing how to read a currency pair.
Currency name abbreviations has three letters. The first two letters represent the country code while the last letter is the initial of the currency itself. For Japan, the abbreviation of their currency is JPY. JP is the country code for japan and the letter Y stands for yen which is their currency. In cases where currency of a certain country is revalued, the last letter is usually set to N to stand for “new”. Some would just change the letter to something different as was the case for Russian ruble which was changed from RUR to RUB. You must be aware of any changes in currencies if you want to trade in forex.
It is useful to note that the major currencies in forex are EUR(euro), USD(US dollar), JPY (yen), GBP (pound sterling), AUD(Australian dollar), CHF(Swiss franc), and NZD(New Zealand dollar). These currencies are the ones most traded in the forex market. Roughly 85 percent of the trade in forex constitute of these currencies.
So how do you read a currency pair? As the name currency pair suggests, there are two currencies forming a currency pair. The currencies in a currency pair are usually separated by a slash. There are also times when the slash is omitted. Do not be surprise if the USD/JPY currency pair is written as USDJPY in some cases. They mean the same thing.
The first currency is called the base currency and the second currency is the counter currency or quote currency. It is then followed by the rates. Most currency exchange rates are quoted out to four digits after the decimal place. The exception of this would be the Japanese yen (JPY), which is quoted out to only two decimal places. Some of beginner traders would wonder why there is a need to have four decimal places when it could be simplified to two. You must remember than currency pairs are traded in bulks and a fraction of a cent in large bulks results to a sizable amount. It is a big deal.
Looking at the USD/JPY 120.00 example, you would not read it as US dollar per yen but yen per dollar. USD is the base currency and yen is the quote currency. So you should think of it like so, how much yen would you pay to get a dollar? In this example, one US dollar($1) is equal to 120 Japanese yen.
Take the EUR/USD 1.2300 quote as another example. In this pair, EUR is the base currency and USD is the counter currency. You would view EUR(euro) as the commodity and USD(US dollar) as the price. Simply put, in order to get EUR, you need to pay 1.2300 USD. So if you want to buy 500 euros, you have to pay 615 USD for it.
The standards for writing currency pair notations have evolved through time. This results to currencies being prioritized over other existing currencies. Through the years, euro has the highest rank among currencies and as specified by the European Central Bank, it has the first precedence as base currency. This means that in currency pairs involving euros, euros would always be used as base currency. This is why the euro and dollar exchange rate for instance, is identified and quoted as EUR/USD pair.
Before, the currency ranking was based on the relative values of currencies among each other. But due to euro and other market factors, the price rankings has changed. It was later that people decided to follow a standard for uniformity’s sake. Thus, order of currency pairs became standardized.
The established priority among major currencies is ranked as follows: Euro(EUR), Pound sterling(GBP), Australian dollar(AUD), New Zealand dollar(NZD), United States dollar(USD), Canadian dollar(CAD), Swiss franc(CHF), and Japanese yen(JPY), with euro having the first precedence. This ranking is by no means set by a formal ruling organization, but nevertheless, it became the convention. You should not only know how to read a currency pair, you must also familiarize yourself to the rankings of the currencies to make your currency searches easier. This is because there are two types of currency quotations.
The two types of currency quotations are the direct currency quote and the indirect currency quote. A currency pair is a direct quote if the domestic currency is the quoted currency. However, if the domestic currency is the base currency, then it is an indirect quote. As mentioned before, currency priority is standardized and it affects how the currency may be written in forex currency charts.
If you want to see the exchange rate between the Japanese yen which is your domestic currency and US dollars which is the foreign currency, you must find the indirect rate. This means that USD is generally written as the base currency this currency pair, so you must look for the indirect quote to make your domestic currency the base currency.
The convention is that US dollars takes precedence over yen. Most trades in forex involve the US dollar currency. Cross currency or the crosses break away from this trend. Popular cross currency pairs are the EUR/CHF, EUR/GBP, and EUR/JPY. The advantage of cross currencies is that they are mostly unaffected to the everyday oscillations or fluctuations of the greenback. This provide them a much cleaner trend signals. They also expand trading possibilities in the market.
Anyway, indirect quotes are what are called to be a quantity quotation since you would want to know the quantity of the foreign currency required to pay for the domestic currency. Basically, the direct quote to the US dollar and Japanese yen example is USD/JPY and the indirect quote is JPY/USD. In the direct quote, domestic currency varies while the foreign currency is fixed to one unit. The indirect quote does the opposite and varies the foreign currency while domestic currency is fixed to one unit.
To wrap up the indirect and direct quotation topic, consider this. Japanese yen is quoted as USD/JPY 100.00, and USD/CAD 1.0600, what is the price of yen in Canadian dollars both in direct and indirect quotations?
In Canada, the indirect quotation would be CAD/JPY 94.34. We convert this by first converting the direct USDCAD quote to its indirect counterpart, CAD/US 0.9434(this is derived by dividing 1 over 1.0600). You now know that one Canadian dollar is equal to 0.9434 US dollar. The next step is to get the Japanese yen equivalent. Remember that exchange rate of USD and JPY is USD/JPY 100.00. So to get the exchange rate between Canadian dollars and yen, you only need to multiply 0.9434 by 100. This would then result to the 94.34. Thus, the CAD/JPY 94.34.
On the other hand, to get the direct quotation of yen and Canadian dollars, divide 1 by 94.34. This would result to 0.0106. You could also get this by dividing 1.0600 by 100. Note that you could get 1USD with 1.0600 CAD and 1USD with 100 yen. Therefore, you could say that 100JPY is equivalent to 1.0600 CAD. 1JPY is then simply the result of 1.0600/100. Thus, the quote JPY/CAD 0.0106.
It sounds confusing at first, but you would get the hang of it with practice. You can try forex simulations to make yourself comfortable dealing with currency pairs. This would be a great practice to sharpen your skills.
In Forex trading, there is a possibility to sell a currency pair prior to buying it. The trick is to sell it high then buy it low. It’s a lot like short selling wherein you borrow in the belief that the borrowed security price would decline in time.
To make an easier example consider this scenario. You borrowed a car from a friend. While using the car, you met someone who wants to buy it from you. This person offered you a price which is $10000 above the original price of the car. You sell your friend’s car and buy a new one. You returned this new car to your friend and made a profit of $10000. Great right? This is what you do when selling a pair before buying it. You sell EUR-USD when the price is high and then buy it when the price is low. If you sell it low, then buy it lower. In order to do this, you should have the skills on how to read a currency pair effectively. You should also need to understand the two position you take when trading.
These terms are used in the forex market. When you buy a currency pair, you take the long position and when you sell, you take the short position. These terms were derived to the observation that prices took longer time to go up and shorter time to go down. This is due to the balance of greed and fear. It was observed that prices go up because of greed and go down because of fear. Usually, fear is much stronger than greed. This results to the price going down faster than it is going up.
So when you buy, you get to have the long position as it would take longer time for prices to go up. On the other hand, you take the short position when selling as the price takes a shorter time to go down.
As you may now have a basic knowledge on how to read a currency pair, it is time that we talk about the bid and ask mechanics of forex trading. When you trade currency pairs there are two prices to take note of. This is the bid price (or buy) and the ask price (or sell).These prices are set relative to the base currency.
When taking the long position or buying a currency pair, the ask price is the amount of the quoted currency that you have to pay in order to buy a unit of the base currency. You use the bid price when selling. This time around, you are going short. The bid price is the amount of the quoted currency you could get when selling a unit of the base currency.
The bid and ask quote is written with the currency pair followed by the bid and ask price separated by a slash. The bid price writes up to four decimal places while in the ask price, just the final two digits are usually written in the quote. This is because the ask price is higher than the bid price by pips.
If you came across with a quote that says USD/CAD 1.2000/05, it means that the bid price is 1.2000 while the ask price is 1.2005. If you are planning to buy the currency pair, you should look at the ask price of the quote. In this case, you would have to pay 1.2005 CAD for 1USD.
If you are planning to sell the currency pair or base currency, then you should look at the bid price instead. Based from the USD/CAD example, you would sell the market 1USD for 1.2000CAD. Easy, right? You got this in the bag already.
The spread is the difference between the ask(buying) and bid(selling) prices. Take a look again at the previous example we had in regards to bid and ask prices, USD/CAD 1.2000/05. The spread in this quote would be 0.0005 or 5 pips also known as points.
As mentioned before, a fraction of a cent is important. Although these figure may seem insignificant to you now, even the smallest point change can result in thousands of dollars being made or lost in the long run. This is true especially when you are dealing with a large amount of currency pair.
Leverage also plays a role in this and even the smallest price movement can result in a huge profit. Again, this is one of the reasons why people, especially speculators, are so attracted to the foreign exchange market. You better master how to read a currency pair to make sure that you would make a profit.
The pip is the smallest value currency quote prices could move. It is often used in trading currencies. It stands for price interest point and shows the slightest movements on the price of currency pairs. If you are familiar with stocks, then you can liken it to the concept of tick. Pip value depends on the size of the lot that is traded. Most brokers though offer a regular contract or lot sizes of 100,00 units of base currency.
By this time, you might ask what currency pairs are the best to trade? It is suggested that you watch out for the currency pairs which are showing strong and sharp signals. These pairs would surely be the best currency pairs to trade at that particular time.
You should also not limit your trading to one form of currency. This is a mistake most traders do when trading. They follow the idea of focusing on one currency pair and mastering it which is wrong. The same rules apply to any currency pairs, so why focus on only one?
Look out for the several currency pairs in the market and grab the opportunities they present. Support line breakouts are sell signals. Find a valid support line and sell it after its breakout. This would give you profit no matter what the currency pair. You are learning how to read a currency pair in order to do this.
As for the most active and volatile currency pairs here is there are. GBP-JPY is the most volatile and the most active currency pair while EUR-JPY takes the second position. The GBP-JPY and the EUR-JPY currency pairs typically go in the same direction. You could say that they are correlated. It means that when one goes up the other goes up as well, and when one’s price goes down, the other would likewise go down without exception. GBP-JPY and EUR-JPY are the most preferred pairs by forex traders. In general, GBP cross currency pairs are the strongest. EUR-USD is the most liquid currency pair. This is because of its trading volume. However, you will not have any liquidity problem with any currency pairs in the forex market as it is such a huge market. Speculators are everywhere.
So you know how to read a currency pair and take advantage of it, but when do you trade exactly? The answer is subjective. Ultimately, you need to trade at a time where a strong and sharp signal could be seen, that’s all. You can have a daily trading session or you can use small time frames. The choice is yours. There are 3 main forex market sessions. London, New York and Asian. London session opens at 8 am and closes 4 am GMT. NY is from 8 am to 4 pm EST. The Asian session runs from 7 pm to 3 am EST.
Forex market has the highest volatility when both the London and New York markets are open. This roughly happens from 8am to 1pm EST. By the time the New York session close, the forex market becomes slow. It becomes busy again when Japan and then Australia started working. This volatility affects the movements of the currency pairs. This opens up trading opportunities. Basically, you trade when market is up and moving.
Remember to think of risk too and don’t pour all your money on this. Have a stash for safekeeping in case of losses. You may know how to read a currency pair now, but know that everything is not all gain. You would expect to get some losses too.