Currency pair

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Currency pair
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A currency pair is a quotation of two different currencies' exchange rate against each other. It is used in foreign exchange (forex) trading and is the value of one currency expressed in terms of another. For example, the notation USD/EUR 0.86 means that one US dollar is equal to 0.86 euros. Generally, the currency to the left of the slash (/) is the base currency, while the currency to the right is the quote currency.

The most commonly traded currency pairs are referred to as the “majors” and include the US dollar (USD), euro (EUR), British pound (GBP), Japanese yen (JPY), Swiss franc (CHF), Canadian dollar (CAD) and Australian dollar (AUD). These pairs account for more than 80% of all forex trading. Other popular pairs include the “commodity currencies” such as the AUD/USD, USD/CAD, NZD/USD and USD/CHF.

The two currencies involved in a currency pair are known as the base currency and the quote currency. The base currency is the one that is quoted first in a currency pair and the quote currency is the second currency in the pair. For example, in the currency pair EUR/USD, the euro (EUR) is the base currency, while the US dollar (USD) is the quote currency. The value of the base currency is always equal to one unit, while the quote currency is the amount of currency that one unit of the base currency can buy.

In conclusion, a currency pair is a quotation of two different currencies’ exchange rate against each other. The most commonly traded currency pairs are referred to as the “majors” and include the US dollar (USD), euro (EUR), British pound (GBP), Japanese yen (JPY), Swiss franc (CHF), Canadian dollar (CAD) and Australian dollar (AUD). The base currency is the one that is quoted first in a currency pair and the quote currency is the second currency in the pair.

Example of Currency pair

  • EUR/USD: The euro is the base currency and the US dollar is the quote currency. This means that one euro is equal to 1.20 US dollars.
  • GBP/JPY: The British pound is the base currency and the Japanese yen is the quote currency. This means that one British pound is equal to 145.55 Japanese yen.
  • USD/CAD: The US dollar is the base currency and the Canadian dollar is the quote currency. This means that one US dollar is equal to 1.31 Canadian dollars.

Formula of Currency pair

The formula for calculating a currency pair is as follows\[\text{Currency Pair } = \frac{\text{Base Currency}}{\text{Quote Currency}}\]

For example, for the currency pair EUR/USD, the formula would be\[\text{EUR/USD } = \frac{\text{EUR}}{\text{USD}}\]

The value of the base currency is always equal to one unit, while the quote currency is the amount of currency that one unit of the base currency can buy. This formula is used to calculate the exchange rate of a currency pair, which is the price of the base currency in terms of the quote currency.

When to use Currency pair

Currency pairs are used by forex traders to speculate on the direction of the exchange rate between two currencies. Traders will buy a currency pair if they believe the base currency will appreciate in value relative to the quote currency and sell a currency pair if they believe the base currency will depreciate in value relative to the quote currency.

Traders may also use currency pairs to hedge their portfolios by taking a long or short position in a currency pair which is based on the expected direction of the exchange rate. Hedging, or taking a position in a currency pair to offset losses in another, can help to reduce risk and protect against market volatility.

Types of Currency pair

There are three main types of currency pairs: major, minor, and exotic.

  • Major currency pairs: Major currency pairs are the most widely traded and liquid currency pairs in the forex market. These pairs typically involve the US dollar and one of the other major currencies such as the euro (EUR), British pound (GBP), Japanese yen (JPY), Swiss franc (CHF), Canadian dollar (CAD) and Australian dollar (AUD).
  • Minor currency pairs: Minor currency pairs are those that involve one of the major currencies paired with a currency from a smaller or emerging economy. Examples of minor currency pairs include EUR/PLN, GBP/CZK, and USD/MXN.
  • Exotic currency pairs: Exotic currency pairs are those that involve a major currency paired with the currency of a developing or emerging market. Examples of exotic currency pairs include EUR/TRY, GBP/ZAR, and USD/SEK.

Advantages of Currency pair

  • Liquidity: Currency pairs are among the most liquid financial instruments in the world and can be traded at any time of the day. This makes them ideal for short-term trading strategies and allows traders to take advantage of short-term market movements.
  • Leverage: Currency pairs offer traders the ability to use leverage, which can magnify profits as well as losses. This means that traders can make more money with less capital.
  • Low transaction costs: Currency pairs typically have low transaction costs, which makes them attractive to both new and experienced traders.

Limitations of Currency pair

  • Liquidity Risk: Liquidity risk is the risk that a trader may not be able to execute a trade at the desired price due to lack of buyers or sellers. This risk is particularly relevant in currency pairs with low trading volume.
  • Exchange Rate Risk: Exchange rate risk is the risk that the value of a currency pair will move in an unfavorable direction. This risk is particularly relevant when trading highly volatile currency pairs.
  • Political Risk: Political risk is the risk that changes in political or economic policies will adversely affect the value of a currency pair. This risk is particularly relevant when trading currency pairs that are heavily influenced by political developments, such as the USD/CNY pair.

Other approaches related to Currency pair

  • Technical Analysis: Technical analysis is a method of forecasting price movements by analyzing past data and trends. It involves studying charts and other market data to identify patterns and trends of a currency pair.
  • Fundamental Analysis: Fundamental analysis is based on the macroeconomic factors that affect a currency pair’s value. It involves looking at economic, political and financial news to determine a currency pair’s direction.
  • Sentiment Analysis: Sentiment analysis is a method of analyzing the sentiment of a currency pair’s traders and investors. It involves looking at how traders and investors feel about a currency pair in order to identify potential opportunities.

In conclusion, there are several approaches that traders can use to analyze currency pairs. Technical analysis involves studying charts and other market data to identify patterns and trends. Fundamental analysis looks at macroeconomic factors that affect a currency pair’s value. Sentiment analysis looks at the sentiment of a currency pair’s traders and investors to identify potential opportunities.

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