You would never buy a house without understanding the mortgage, right? My goal with this lesson is to take you from understanding the basics to becoming a complete currency guru. As you might have guessed from its name, each pair involves two currencies. By process of elimination, you know that the quote currency is the one that comes second in a pairing. Because the Forex market never sleeps and thus currency values are always changing, both the base currency and quote currency are in a constant state of flux.
Conversely, if the Euro weakened the pair would fall, all things being equal. And if the USD weakened, the currency pair would rally as the Euro would gain relative strength against its US dollar pairing. In this instance, the Euro is strengthening against the US dollar.
Here the Euro is weakening against the US dollar. As you can imagine, the velocity of any move depends on the relationship between the two currencies. For instance, if one is strengthening while the other is weakening, the move will be more pronounced than if only one currency is on the move. In the stock market, you can either buy and sometimes sell shares of stock. There are no pairings, and the value of one stock is not dependent on that of another.
However, in the Forex market, all currencies are paired together. To clarify, this does not mean you have to place two orders if you want to buy or sell a currency pair. As a retail trader, all you need to know is whether you want to go long or short.
Your broker handles everything else behind the scenes. At this point, you should have a firm understanding of what a currency pair is as well as the dynamics of buying and selling. These currency pairs are to the Forex market what Apple and Amazon are to the stock market. They are by far the most popular and therefore the most liquid.
Every major currency pair includes the US dollar. Everyone wants to trade the major pairs listed above. In fact, making this mistake can quickly lead to forcing trades and overtrading. So if the major pairs include the US dollar, we can infer that minor currency pairs are those that do not include the US dollar. The truth is, there are far more currency crosses than there are minor pairs.
Minor currency pairs, on the other hand, make up a fraction of the crosses that are available for trading. A currency cross is any pair that does not include the US dollar. A minor pair, on the other hand, is a major currency cross. The tables below should help to clear things up. But if the major currency pairs get most of the attention and carry the most liquidity, why would anyone want to trade minor currency pairs and especially crosses?
Make no mistake, while the daily volume for these crosses is less than the majors, they are certainly not illiquid by any means. Remember that the foreign exchange market is the most liquid financial market in the world, so even some of the less popular currencies are extremely liquid. The exotic currency pairs are the least traded in the Forex market and are therefore less liquid than even the crosses we just discussed.
Additionally, the technical analysis we like to use here at Daily Price Action is less reliable. As a general rule of thumb, the more liquid a market is, the more you can rely on the technicals. While the table above is fairly comprehensive, it is by no means a complete listing of every exotic currency in the world. However, it does cover some of the most popular of the less popular exotics. But before you rush off to add this basket of currencies to your trading platform, there are a few things you should know.
As I mentioned earlier, these Forex exotics are less liquid than their more standard counterparts. And while most of them can easily support the majority of retail orders, the lack of volume can adversely affect the spread between the bid and the ask. Also, in my experience, the study of technical analysis works best in highly liquid markets. This is one reason why I made the transition from equities to Forex in Because the exotic currency pairs lack sufficient liquidity, at least compared to that of other pairs, the accuracy of technical analysis can suffer.
So even if you find a pair that has a favorable spread, the lower volume may adversely affect your trading performance. At least two or three times a week I scan back several years on a particular currency pair.
In other cases, your broker may not offer the data. While you may be able to find a few that have favorable movement, for the most part, they are extremely choppy and volatile currencies to trade. As you can see, the price action above is less than ideal. Last but certainly not least is the opportunity cost associated with trading exotic currency pairs.
Of course, you could make the same case about any position, but with dozens of other currency pairs at your disposal, you certainly have to weigh the opportunity cost associated with trading a less liquid market.
Developing countries such as Burundi and Tanzania are among them. However, it also applies to countries such as Canada, Australia, and New Zealand. The US dollar versus the Canadian dollar is one of the more sensitive commodity currency pairs.
This sensitivity is due to the vast amount of natural resources that flow from Canada, much of which makes its way to the United States. Among these natural resources is oil, which is a primary export for Canada and one that is vital to the health of the global economy.
In fact, Canada exports over 2 million barrels a day to the US alone. This high dependency on the commodity as an export makes the Canadian dollar vulnerable to fluctuations in the price of oil. This relationship means that when oil rises the Canadian dollar strengthens. Conversely, when oil depreciates so too does the CAD. In fact, as of the country was the second largest gold producer only second to China. It matters because investors tend to flock to gold during times of economic unrest.
During times of economic uncertainty or struggle, investors tend to favor the US dollar. The Australian dollar also tends to track equities, so when these markets began to capitulate back in so too did the AUD.
Despite the small size of New Zealand, the small island nation has an abundance of natural resources. Rather, the currency is affected by a basket of commodities and is one of the top exporters of milk, meat, and fruits. A safe haven is any asset that has a strong likelihood of retaining its value or even increasing in value during market downturns. During the global crisis, for example, gold was locked into a range and really only managed to move sideways with slight gains seen towards the end of the recession.
Remember that if the quote currency experiences heavy appreciation, the pair is likely to move lower over time. Last but certainly not least is the Japanese yen, another currency that has a long history of safe haven status. As you can see, the Japanese yen appreciated massively against all three of its counterparts above. Over the years the yen has been one of the more consistent safe haven currencies, which has made it my go-to currency when fear begins to grip global markets.
But just because an asset held its value or appreciated during the last market downturn does not mean it will behave in the same manner in the future. However, the assets mentioned above do have a history of retaining their value when things turn sour.
These commonalities lead to both positive and negative associations. So you get the idea. Again, pretty basic stuff but yet essential knowledge if you wish you achieve consistent profits in the Forex market. Because managing risk is your number one job as a trader. For example, if you sell two negatively correlated pairs, chances are only one of the two trades will be successful.
With that said, the pairs I started with back in are highlighted in the table above. Wow, this lesson is now over 4, words. Who knew someone could write so much about Forex currency pairs?
Many traders make the mistake of skipping these necessary steps before putting their hard-earned money at risk. As they say, knowledge is power. And nothing is more powerful for a trader than understanding the currency pairs that make up the Forex market. I sincerely hope this lesson has answered any question you may have had. As always, if I missed something, please let me know in the comments section below. I always make it a point to respond. Please log in again.
The login page will open in a new window. After logging in you can close it and return to this page. How do I know that many traders skip this step? In addition to receiving hundreds of emails every month, I was once a beginner too. Anatomy of a Currency Pair. The Dynamics of Buying and Selling Currencies. Currency Baskets Majors, Minors and Crosses. Your Virtual Bomb Shelter. Session expired Please log in again.More...