In the eyes of the Forex investor, the currency market is the combination of all the currency pairs available to trade. So, understanding what a currency pair is, and why and how it moves, is crucial in the decision to buy or sell.
First, we need to address some of the terms used by investors when referring to various currencies or currency pairs. The most popular ones are:
- GBP/USD – also called “the cable”, after the first cable laid on the bottom of the Atlantic Ocean that connected the two major financial centers: London and New York
- USD/CAD – the Loonie pair
- AUD/USD – the Aussie pair
- NZD/USD – the Kiwi pair
- EUR/USD – the fiber pair
Majors and Crosses – The USD Division
The primary division in the currency pairs is the U.S. Dollar (USD). As the world’s reserve currency, everything in the currency market revolves around the USD.
Most international trades take place in dollars; commodities (e.g. oil) are bought and sold in dollars, and even international loans are mostly in USD. Therefore, it should come as no surprise that the USD is what divides currency pairs into two categories; majors and crosses.
A major pair is any currency pair that includes the USD as one of its two currencies. The most important currency pair is the EUR/USD (the most liquid and popular with retail Forex traders), then the GBP/USD and then USD/JPY, AUD/USD, USD/CHF, USD/CAD or NZD/USD.
Major pairs show how the USD fluctuates against other relevant currencies in the international market. Their importance is related to the size of international trade for each currency. As mentioned, the USD gets the most significant chunk of it, followed closely by the Euro (as the common currency of the Eurozone), JPY (Japanese Yen), GBP (Great British Pound), etc.
Currency pairs that don’t include the USD are called cross pairs. Some essential cross pairs reflect the size of trade between two countries like EUR/GBP, EUR/AUD, GBP/JPY, etc.
Investors must come to think of these currency pairs as being grouped in threes. For every cross-currency, two major currencies exist.
Let’s take the GBP/JPY mentioned above. As a cross, it’ll move based on the differences between the two majors, in our example the GBP/USD and USD/JPY. Take USD out of the equation, and you’ll be left with the GBP/JPY cross.
Hence, when trading either one of the three pairs, one needs to consider them all. For instance, if both GBP/USD and USD/JPY are bullish (the first because of the U.K.’s positive economic evolution for example, and the second because of the Bank of Japan devaluing the JPY, as another example), the best possible pair to trade is the cross pair. The GBP/JPY will rise more due to two majors moving in the same direction.
- Some currencies and currency pairs have nicknames.
- USD holds the key to defining the Forex market.
- Crosses need to be analyzed in three: 2 majors per 1 cross.
- Currency pairs have different liquidity levels depending on the size of their international trade.