A Better Understanding of Currency Pairs and How Speculators Buy and Sell Them

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Have you heard the term “currency pair” but never understood what it was? It is actually a quote that features two different currencies (EUR/USD) with one currency quoted to the terms of the other. Currency exchange rates are always quoted in this manner. Each currency has been given an International Standards Organization code abbreviation, which is generally used to create the currency pair.

  • USD – U.S. dollar
  • JPY – Japanese yen

When you look at a currency pair, the first listed currency is the “base currency”, while the second is called the “quote currency” or “counter currency.”

The base currency always has a value of one. So, when looking at the currency pair, you can note that one unit of base currency can buy a number of units of the quote currency. Think of it this way: how many $1 bills can you get for Japanese yen, if the yen sits at 110? Simply put, $1 USD can buy 110 Japanese yen, and $5 USD can buy 550 yen.

When speculators buy and sell currency pairs

Speculators will purchase a currency pair if they believe the base currency is going to rise in respect to the counter currency, or that the corresponding exchange rate is going to rise. Speculators will sell the currency pair in the hope that the base currency is going to lose value when compared to the counter currency, or that the counter currency is going to increase when compared to the base currency.

Forex trading means buying one currency and selling another at the same time. When you buy a currency pair, you purchase the base currency and sell the counter currency.

The “bid” is the price you will sell the base currency and buy the counter currency for. The “ask price” is what you can purchase the base currency and sell the counter currency for. When it comes to the bid and ask price, the bid price is always lower. The difference between them is known as the “spread.”

Currency trading and the economy

When it comes to currency trading, the most politically steady and economically liquid currencies are more in demand than currencies situated in less stable regions. Due to the U.S. economy’s size and strength, the American dollar is the most traded currency on the market, which is also why it is typically the base currency with regard to quotes. The big, commonly traded currencies are the following:

  • U.S. dollar
  • Canadian dollar
  • Euro
  • Swiss franc
  • New Zealand dollar
  • Australian dollar
  • Japanese yen
  • British pound

Currency pairs with the involvement of the U.S. dollar are known as “cross rates.”

When the base currency is the U.S. dollar and the currency rate rises, it means the dollar has gone up in value and the other currency has dropped.

This rule, however, has three exceptions:

  • Australian dollar
  • British pound
  • Euro

When these cases happen, a quote of GBP/USD 2.476 implies that just one British pound equates to 2.476 U.S. dollars. When the U.S. dollar is not the base rate, a rising quote means the dollar is weak. It takes more U.S. dollars to equal one Australian dollar, euro, or pound. If the currency quote is higher than the base currency, it means the base currency is actually weaker.

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