A good reason to consider trading forex involves the relatively low learning curve involved in trading the various currency pairs.
Another popular characteristic of the forex market is the fact that most currency trading activity is confined to a small number of key currencies and currency pairs, often called the majors.
This limited scope allows forex traders to focus on a much smaller number of instruments, compared to having to select among thousands of stocks or through a long list of commodities to determine which would be the most profitable instrument to trade.
The following sections describe the main currencies and currency pairs actively traded in the forex market.
These key currencies, listed in order of importance and daily volume, include the:
- USD – U.S. Dollar
- EUR – European Union Euro
- JPY – Japanese Yen
- GBP – Great Britain Pound Sterling
- CHF – Switzerland Franc
- AUD – Australian Dollar
- CAD – Canadian Dollar
- NZD – New Zealand Dollar
The above list represents the eight major currencies which were involved in roughly 87% of all currency trading volume, as of 2007.
Also, the U.S. Dollar is involved in over 86% of all forex trades, being either the base or the counter currency in all of the so-called major currency pairs.
Currency Pairs in General
Basically, currencies can only have value relative to one another, unless measured against a commodity such as gold. The relative value of a currency is therefore measured against another currency, resulting in the pairing of two currencies into a currency pair.
Currency pairs are made up two currencies, the first of which is the base currency, and the second is the counter currency in the pair. In standard forex market notation, the three letter ISO 4217 code for the base currency is separated from the counter currency with a slash “/”.
For example, EUR/USD represents the Euro – U.S. Dollar currency pair, with the Euro being the base currency and the U.S. Dollar acting as the counter currency.
If the exchange rate at the time is 1.2500, this means that it takes 1.2500 U.S. Dollars to purchase one Euro. Since the Euro is the base currency, the rate is quoted in terms of the counter currency, which is the U.S. Dollar in this case.
For the USD/JPY currency pair, the rate is quoted in the number of Japanese Yen per one U.S. Dollar. Hence, the rate might be quote as 88.50 Yen per U.S. Dollar, for example.
The Major Currency Pairs
What follows is a brief description and explanation of the most active forex currency pairs by volume, also commonly known as the “majors” in the forex market that each trade as a separate instrument.
- EURUSD – The European Monetary Union’s Euro quoted in terms of the U.S. Dollar. This currency pair compares the currency of the largest economy in the world against that of the second largest economy in the world by GDP. This key currency pair accounts for more than 27% of total daily forex trading volume, according to the Bank for International Settlements or BIS. EURUSD is the IBM of the currency market and moves something like a blue chip stock exhibiting sweeping, long, trending moves with occasional extreme volatility, which makes trading this pair ideal for newer forex traders.
- USDJPY – The number two currency pair as far as daily trading volume, the U.S. Dollar against the Japanese Yen makes up a total of 13% of total daily forex trading volume. This currency pair also trades with trending moves and tends to have lower volatility than EURUSD. Nevertheless, because of the high liquidity in this currency pair, its dealing spreads tend to be tight and therefore attractive to scalpers. The U.S. and Europe make up Japan’s largest trading partners.
- GBPUSD – Third on the list is the Pound Sterling against the U.S. Dollar. Nicknamed Cable, this currency pair has a long history going back to the days after the Civil War when the Trans-Atlantic Cable was used for many transactions in the 19thcentury. Cable makes up over 12% of overall daily forex trading volume and tends to be a bit more volatile than either EURUSD or USDJPY. The rate is also prone to wild swings at times and can suffer from liquidity issues. For this reason, this currency pair is not recommended for novice traders.
- AUDUSD – The Australian Dollar versus the U.S. Dollar. Basically a commodity currency, the Aussie Dollar often reacts to price movements in the major commodities which it produces. The country also does a large amount of business with China which buys a large portion of Australia’s exports.
- USDCAD – The Canadian Dollar versus the U.S. Dollar. The Loonie, as it is sometimes known in forex circles, is another commodity currency with a particular sensitivity to the price of oil since Canada is a major producer and exporter of oil. USDCAD tends to trade in a somewhat orderly fashion and thus has a lower volatility.
- NZDUSD – The New Zealand Dollar versus the U.S. Dollar. While not as actively traded as the Aussie Dollar, the NZD or Kiwi is yet another commodity currency since the New Zealand economy is also largely dependent on the export of natural resources.