Forex trading is the buying and selling of currency pairs. In other words, you will be buying one currency while selling another currency. Each currency pair has an exchange rate which fluctuates as one currency gets stronger against the other. When trading a currency pair, you hope to make a profit by speculating whether a currency will appreciate or depreciate against another currency. There are four major currency pairs, which we will look at more closely.
The Major Currency Pairs
There are four major currency pairs. They have very liquid markets, have narrow spread and are traded at all hours of every business day. These include:
- EUR/USD – the euro and the US dollar
- USD/JPY – the US dollar and the Japanese yen
- GBP/USD – the British pound sterling and the US dollar
- USD/CHF – the US dollar and the Swiss franc
The US dollar is the most widely held currency and the most heavily traded currency in the world. The euro comes in at number 2. Because these are the 2 most popular currencies in the world, they are also the currency pair which is most actively traded. The relative strength of the two economies is what primarily drives the direction of the pair. A significant factor in the strength of the euro is the political stability between members of the European Union.
Japan has the largest economy in Asia. Its currency is strong due to the large amount of trading that Japan does with the US and Europe, as well as due to the low interest rates in the country. This currency pair has excellent liquidity and is a heavily traded pair, which is particularly popular among those who are new to trading.
Despite its size, the UK is influential in international financial markets. While no longer the leader of world economies like it used to be, the UK has remained relatively prosperous and therefore the pound sterling is commonly traded against the US dollar. This is one of the most liquid of the currency pairs and all types of traders choose this major pair to trade.
Switzerland, a stable nation with a history of private banking and investment management options, is considered a prosperous country. Switzerland is not part of the European Union, maintaining its neutrality, while enjoying a strong trading relationship with countries in the EU and the United States. Its currency is important in international capital markets. The USD/CHF is not as liquid as a pair such as the EUR and GBP, but it is still relatively easy to trade.
Trading the Pairs
It is important to understand what impacts the currencies that are being traded. For example, when political or economic turmoil is greater, people prefer to buy the Swiss Franc, viewing it as a stable and safe currency. These types of world events will impact how one currency performs against another and so you need to keep your finger on the news when trading major currency pairs.