Currencies are Traded in Pairs
Forex trading is the simultaneous purchasing of a particular currency and selling another. Currencies are traded through a broker or dealer, and are traded in pairs; for example the euro and the U.S. dollar (EUR/USD) or the British pound and the Japanese yen (GBP/JPY).
When you trade in the forex market, you purchase or sell in currency pairs.
Imagine all pairs constantly in a “tug of war” with each currency on its own side of the rope. Exchange rates change based on which currency is stronger at the moment.
Major Currency Pairs
The following currency pairs are known as the “majors”. These pairs all contain the U.S. dollar (USD) on one side and are the most often traded. The majors are the most liquid and most traded currency pairs in the world: EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, AUD/USD, and NZD/USD.
Major Cross-Currency Pairs or Minor Currency Pairs
Currency pairs that don’t include the U.S. dollar (USD) are known as cross-currency pairs or simply the “crosses.” Major crosses are also known as “minors.” The most actively traded crosses contain the three primary non-USD currencies: EUR, JPY, and GBP.
Some of the Euro Crosses are: EUR/CHF, EUR/GBP, EUR/CAD, EUR/AUD, and EUR/NZD.
The following are considered Yen crosses because they use the Japanese Yen on one side: EUR/JPY, GBP/JPY, CHF/JPY, CAD/JPY, AUD/JPY, and NZD/JPY.
Just like Europe, Great Britain has their own crosses as well: GBP/CHF, GBP/AUD, GBP/CAD, and GBP/NZD.
And here are some other currency pairs that are considered minors: AUD/CHF, AUD/CAD, AUD/NZD, CAD/CHF, NZD/CHF, and NZD/CAD.
Exotic pairs are made up of one major currency connected with the currency of an emerging economy, such as Brazil, Mexico, or Hungary. Here are some examples of exotic currency pairs: USD/HKD, USD/SGD, USD/ZAR, USD/THB, USD/MXN, USD/DKK, USD/SEK, and USD/NOK.
It isn’t uncommon to have spreads that are two or three times larger than that of EUR/USD or USD/JPY. So if you want to trade exotics pairs, remember to consider this in your decision.
Because the foreign exchange market is so extraordinary, traders came up with a few different methods to invest in currencies. Of these, the most common ones are forex spot market, futures, options, and exchange-traded funds (or ETFs).
In the spot market, currencies are traded immediately or “on the spot,” using the current market price. What are so awesome about this market are its small spreads, and 24 hour operations. It’s extremely easy to participate in this market since accounts can be opened with as little as a $25 investment! And most brokers ordinarily provide charts, news, and other information for free.
Futures are contracts to purchase or sell a particular asset at a particular fee on a date in the future. That’s why they’re called futures! Forex futures were designed by the Chicago Mercantile Exchange (CME) a long time ago in 1972. Since futures contracts have certain standards and are traded through a centralized exchange, the market is extremely transparent and well-regulated. This means that the price and transaction details are easily available.
An “option” is a financial instrument that gives the buyer the ability, or the option, but not the obligation, to purchase or sell an investment at a specified price on the option’s completion date. If a trader “sold” an option, then he or she would be happy to order or sell an asset at a specific fee at the completion date.
Just like futures, options are also traded on an exchange, such as the Chicago Board Options Exchange, the International Securities Exchange, or the Philadelphia Stock Exchange. But, the disadvantage in trading forex options is that market hours are limited for particular options and the liquidity is not nearly as great as the futures or spot market.
Exchange-traded funds or ETFs are the newest members of the foreign exchange market. An ETF could contain a set of stocks in combination with some currencies, allowing the trader to diversify with other assets. These are produced by financial institutions and can be traded like stocks through an exchange. Like forex options, the restriction in trading ETFs is that the market isn’t accessible for all hours. Also, since ETFs contain stocks, these are subject to trading commissions and additional transaction fees.