Every trade in the market involves exchanging one currency for another, creating a pair. These pairs reflect the value of one currency against the other, and traders use this relationship to seek profit from price movements.
Currency pairs are categorised into three main types: majors, minors, and exotic pairs. For this article, our focus will be on majors and minors, as they dominate the forex market.
What Are Currency Pairs?
A currency pair represents the exchange rate between two currencies. The first currency is called the base currency, and the second is the quote currency. The quoted price shows how much of the quote currency is needed to purchase one unit of the base currency.
Example: In EUR/USD, EUR is the base currency, and USD is the quote currency. If the rate is 1.10, it means one euro is equal to 1.10 US dollars.
Major Currency Pairs
Major pairs are the most traded currency pairs in the forex market. Each major pair includes the US dollar, paired with another major global currency.
Key Features of Major Pairs:
- High Liquidity: Major pairs are traded in enormous volumes daily, ensuring minimal difficulty in entering or exiting trades.
- Tight Spreads: Due to their popularity, transaction costs are generally lower.
- Stable Movements: While influenced by global events, their price action tends to be more predictable compared to less popular pairs.
Examples of Major Pairs:
- EUR/USD: Known as the most liquid and actively traded pair globally.
- GBP/USD: Often called “Cable,” reflecting the economic health of the UK and the US.
- USD/JPY: Popular for its stability and relevance to risk sentiment in global markets.
- AUD/USD: Affected by commodity prices, especially metals and minerals.
- USD/CHF: Seen as a safe-haven pair due to Switzerland’s economic stability.
- USD/CAD: Closely linked to oil prices given Canada’s position as a major oil exporter.
Minor Currency Pairs
Minor pairs, also referred to as cross-currency pairs, do not include the US dollar. Instead, they involve combinations of other major currencies.
Key Features of Minor Pairs:
- Moderate Liquidity: While not as frequently traded as majors, minors still have significant activity.
- Higher Spreads: Transaction costs can be higher due to lower trading volumes.
- Regional Influences: Their movements are shaped by economic conditions and events in their respective regions.
- Higher Volatility: They often exhibit sharper price movements, creating both opportunities and risks for traders.
Examples of Minor Pairs:
- EUR/GBP: Reflects the relationship between the economies of the eurozone and the UK.
- GBP/JPY: Known for its volatility and rapid price swings.
- EUR/AUD: Represents the dynamics between the eurozone and Australia.
- AUD/JPY: Affected by global commodity prices and risk appetite in financial markets.
Practical Tips for Trading Majors and Minors
- Start with Majors: Their predictability makes them a great starting point for new traders.
- Watch Economic News: Events like interest rate decisions, inflation reports, or political developments can significantly impact these pairs.
- Assess Risk Tolerance: If you prefer steady trends, stick to majors. For those comfortable with volatility, minors might offer more opportunities.
- Use Demo Accounts: Test trading different pairs in a simulated environment before committing real money.
While major and minor currency pairs dominate forex trading, exotic pairs also play a unique role in the market. Exotic currency pairs consist of one major currency paired with the currency of a developing or emerging economy.
For example:
- USD/TRY: US Dollar and Turkish Lira
- EUR/ZAR: Euro and South African Rand
- GBP/THB: British Pound and Thai Baht
Characteristics of Exotic Pairs
1. Lower Liquidity
Exotic pairs are not as actively traded as majors or minors. This lower trading volume can make it harder to enter or exit positions quickly, particularly for larger trades.
2. Wider Spreads
The transaction costs for trading exotic pairs are usually higher due to the lower demand and supply. This can impact profitability, especially for short-term traders.
3. Higher Volatility
Exotic pairs often experience significant price fluctuations, influenced by political instability, economic developments, or changes in commodity prices. While this creates opportunities, it also increases risk.
4. Economic Sensitivity
The currencies of emerging markets are heavily impacted by factors such as inflation rates, foreign investment, and trade policies. Traders must stay informed about the specific economy linked to the exotic currency.
How Exotic Pairs Fit Into Your Trading Strategy
Beginners: Exotic pairs are not ideal for those new to forex trading due to their volatility and costs. Starting with majors is a safer approach.
Advanced Traders: For experienced traders looking to explore new opportunities, exotic pairs can offer high rewards, provided the risks are well-managed.
Before trading exotic pairs, take the time to understand the economic factors influencing the specific currency. Monitor geopolitical developments, commodity prices, and central bank policies.
By knowing the characteristics of currency pairs, traders can choose the ones that align with their goals and strategies.
Take the time to explore. Begin by trading a major pair like EUR/USD to grasp the market’s rhythm, and when you are ready, consider venturing into minors like GBP/JPY to expand your expertise. The better you understand the pairs you trade, the better prepared you will be to handle the challenges and rewards of the forex market.
