The term currency pair is utilized to describe the relative value of a currency unit against another currency. These currencies are exchanged in the foreign exchange market. There are several kinds of currency pairs. Each pair has different characteristics and trading signals. Here are some of the basics about currency pairs: Base currency, Quote currency, Correlation, and FDI.
Base currency
In the foreign exchange market, currency pairs refer to currency transactions where the value of one of the currencies is quoted against the value of the second one. The first currency that remains listed in a pair is called the base, and another is the quote currency. The most popular pairs are USD/CAD, EUR/USD, and AUD/USD.
There are many different types of currency pairs. Some stand out as more generalized than others, but they all have common characteristics. There are two main types: majors and exotics. Prominent currency pairs get to be the most liquid and stable, while exotic pairs are less liquid and have much higher spreads.
Quote currency
If you want to know how to trade on the forex market, you should understand how currency pairs are quoted. Currency pairs are valued using bid and ask prices. The bid price turns out to be the price a forex broker is willing to pay to purchase the base currency, as the asking price is the price a forex broker is willing to pay to sell the base currency. Both currencies are priced in dollars, so the bid price represents how much one currency is worth when compared to the other.
The most generally traded currency pairs are called Majors and are the ones that account for most of the trading volume in the foreign exchange market. The high market liquidity of these currency pairs makes them popular among investors.
Correlation
Correlation between currency pairs is the relationship between a currency’s value and another currency’s value. When the US dollar is weak, the other currency tends to increase in value. Similarly, when the UK pound falls, the UK FTSE 100 index goes up. This is because many companies in the UK make a large part of their profits in US dollars. As a result, when the value of the sterling is weak, international transactions are worth more.
The correlation between currency pairs can be a very useful tool for traders. It is important to pay attention to news and price charts of currency pairs that correlate with each other. In specific, you will want to pay attention to the EUR/USD pair, as news about it has a significant effect on the British pound.
Influence of FDI
The FDI inflow in a country has a direct impact on the exchange rate. It can either increase or decrease its value. While some researchers have found no correlation between FDI and currency pair values, others have shown a negative relationship. In Bangladesh, a country pioneering a floating exchange rate policy, the FDI-exchange rate nexus is less clear. However, one study suggests that FDI inflows decrease when the exchange rate appreciates.
FDI inflows are also influenced by the institutional and social characteristics of a country. Studies have identified key factors such as effective governing, effective regulations, voice and accountability, and economic freedom. Other indicators include government spending and GDP growth rates.
Trading volume
The trading volume of currency pairs is an important factor to consider in the currency trading market. The larger the volume of trade, the lower the spreads. However, currency trading volume is not the same as stock market trading volume, which is measured in contract value. Currency trading volume is measured in real-time ticks. This differs from stock market contracts, where each tick represents the smallest viable price change. A high tick frequency means higher volume. Moreover, liquidity providers, who participate on both sides of the currency trade, offer data on their volume. They have the power to set price trends.
A major currency pair is one that involves the United States dollar and the euro. It is the most generally traded currency pair in the world, with the EUR/USD representing 28% of the daily global trading volume. A minor currency pair is one that is not closely associated with a major currency and has a wider spread than a major currency pair. However, the major currency pairs represent the largest trading volume, so if you are interested in foreign currency trading, it’s advisable to go for the majors.
Spreads
Forex traders use spreads on currency pairs to make a profit from price fluctuations. They place two contracts on the same currency pair and bet on which one will rise or fall. Forex is a huge market, and the daily turnover is in excess of three trillion dollars. However, spread betting differs from traditional trading and does not take place on a centralized trading floor.
The spread signifies the difference between the bid and the asking price. It is also called the buy-sell spread or brokerage commission. Different brokers use different spreads. Some brokers may even offer a zero-spread trade.