A currency pair is a quotation that features two different currencies, with one being quoted in terms of the other. A currency exchange rate will always be quoted in a currency pair like EUR/USD or USD/JPY. All currencies are assigned an ISO (International Standards Organization code), used to express the currencies that make up a currency pair. For example, USD/JPY indicates two currencies: the U.S. dollar and the Japanese yen.
The first currency in a pair is called the base currency, and the second is the counter currency, or the quote currency.
The value of the base currency is 1, and this never changes. It is easy to remember just by looking at a currency pair and asking “one unit of the base currency will buy how many units of the counter currency?”
Many currency pairs are expressed in terms of dollars, with USD taking the role of the base currency. For example, a quote of USD/JPY 119.25 means that one U.S. dollar is equal to 119.25 Japanese yen.
Buying and selling
A speculating trader will buy a currency pair if he/she thinks the base currency will increase in relation to the quote currency, or that the corresponding exchange rate will rise. A speculating trader will sell a currency pair if the base currency’s value decreases, or if the quote currency’s value goes up.
Forex trading usually involves simultaneously buying one currency while selling another. When you purchase a currency pair, you purchase the base currency and sell the quote currency. The price at which you can sell the base currency while simultaneously buying the quote currency is referred to as the bid. The price at which you can buy the base currency while selling the quote currency is called the ask price. The bid price is always lower than the ask price. The difference between the bid and the ask price is referred to as the spread.
In currency trading, the most liquid and steady currencies are more in demand than currencies that are not considered as stable. Because of the United States economy’s size and strength, the American dollar is the world’s most actively traded currency, and is normally the base currency for quotes. The “majors” – the most liquid and most commonly traded currencies – are the U.S. dollar, the British pound, the Canadian dollar, the New Zealand dollar, the Swiss franc, the euro, the Australian dollar, and the Japanese yen. Currency pairs that do not involve the U.S. dollar are called the cross rates. A euro cross, for example, has the euro in the currency pair.
When the U.S. dollar is the base currency, and the currency quote goes up, it means that the dollar has appreciated in value, while the other currency has weakened. In the previous example of the Japanese yen and the U.S. dollar, if the USD/JPY quote increases to 110.60, then the dollar would become stronger since it can now buy more yen.
The three exceptions to this rule are the British pound, the Australian dollar, and the euro. In these cases, a quote of GBP/USD 2.0574 implies that one British pound equals 2.0574 U.S. dollars. In these three currency pairs, where the U.S. dollar isn’t the base rate, a rising quote means a weakening dollar because more U.S. dollars are needed to equal one pound, euro, or Australian dollar.