Trading

How do forex pairs and spread work?

The forex market is the most liquid in the world. Each day, more than $5 trillion in foreign exchange transactions are made. So, which forex pairs are most popular among traders? We explain the basics of forex pairs to new traders who are not familiar with them.

How do forex pairs work?

A forex pair is a currency-to-currency comparison. A pair has two parts: the base currency and the quote currency. The base currency is the initial currency in a pair. It is the currency the trader believes the quote currency will rise or fall against. For example, to sell the Japanese Yuan against the US Dollar (JPY/USD), you are expecting the Japanese Yuen to fall against US Dollar.

The three main types of forex pairs include:

Major currency pairs

The most traded currencies are the major currency pairs. They are currencies from the biggest and most stable economies worldwide. The most popular pairs include GBP/USD, EUR/USD, and USD/JPY. Due to their liquidity and low spreads, the major currency pairs appeal to both advanced and novice traders.

Minor currency pairs

The US dollar is not included in minor currency pairs (also known as cross-currency pairings). However, they still include widely traded currencies like the euro and pound sterling. However, because of their lower liquidity and higher spreads, minor currency pair are less popular among traders.

Exotic currency pairings

Exotic currency pairings combine a major currency, such as the US Dollar or the Euro, with the currency of an emerging nation like Brazil or Turkey. These pairs are not traded as often as major and minor currency pairs, so they have lower spreads.

Factors that affect Forex pairs prices

Understanding the factors that influence forex markets is important before trading. Some of these factors include:

Monetary policies

The currency markets can be affected greatly by decisions made by the central bank. For example, changes in interest rates can have an impact on currency appreciation or depreciation. Central banks can raise interest rates to increase the value of a country’s currency. However, lower interest rates may decrease the currency’s value.

Financial stability

A currency’s economic stability will determine its value. For example, stable countries like Japan and the US tend to attract large amounts of foreign investment. This increases their currencies’ value. On the other side, less stable economies tend to attract less foreign investment, which results in a weaker currency.

Politics

Political events can have a major impact on currency strength. The UK leaving the EU is one prime example. This Brexit created uncertainty about the UK’s future economic prospects and caused traders to lose trust in the pound. This led to a significant drop in its value against other major currencies.

The most popular forex pairs

Because they offer higher liquidity and lower spreads, the major currency pairs are among the most popular forex pairs. Here’s a list of the four most popular currency pairs.

EUR/USD

This currency pair is also known as “The Fiber,” and it is the most frequently traded in the world. This currency pair represents a big share of the forex market transactions. This is not surprising, considering they are the currencies of the two most important economies in the world. This currency pair is highly traded, and spreads are lower. This makes it an attractive option for novice traders who are still learning about Forex.

USD/JPY

This currency pair is also known as “The Gopher,” and it is one of the most preferred pairs for traders. It is extremely liquid and has very low spreads, just like EUR/USD. This allows traders to trade the currency pair without worrying about fluctuations in exchange rates.

GBP/USD

The British Pound to US dollars currency pair, also known as “The Cable,” is commonly traded. Because of the frequent price swings, this currency pairing is more volatile than The Fiber and The Gopher. Some traders like this volatility as it can offer higher returns. But it can also result in large losses.

USD/CHF

Although the pair USD/CHF is often called “Swissie,” it may surprise many individuals since Switzerland isn’t a major economy. The good reputation of Switzerland as a safe place to live is why this currency pair is so popular. The Swiss franc is a reliable currency that traders can rely on in times of economic uncertainty. It has a stable financial system and government. Although it is not as liquid as the other major currencies listed, it remains very popular with traders.

What are spreads?

Spread is the difference in the price of a particular financial instrument between its buy (bid) or sell (ask). It is also a major cost associated with CFD and Forex trading. Therefore, a narrow spread is better for traders.

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