Buying and Selling Currency Pairs
Forex or forex is the world’s largest market. It sees a daily trade volume of over $6 trillion. This is a huge market that’s open around the clock and five days a week. It’s used to change world currencies between individuals, banks, and companies.
To participate in this marketplace, you need to know the basics of buying and selling this product. Forex trading always involves pairs. People can’t buy a currency without selling it simultaneously.
This guide will break down how currency pairs work, the different types of pairs, and how you can start trading them safely.
What Is Forex Trading?
Forex trading involves trading two currencies at the same time. See a currency pair as an on-going tug of war battle. Each currency is on one side of the rope. The exchange rate fluctuates depending on the currency’s current strength.
When you trade forex, you use a forex broker or a contract for difference (CFD) provider. These types of services will get you in touch with the world wide web of banks trading currencies. This network is known as the over the counter market.
Understanding Base and Quote Currencies
There are two components to every currency pair. The first currency shown is the base currency. The second currency is the quote currency, which people also call the counter currency.
As an example, the Euro and the U.S. dollar have been compared, shown as EUR/USD. If the price of EUR/USD is 1.2500, it means that one Euro is worth 1.2500 U.S. dollars. In this instance the base currency will be Euro and the quote currency is the U.S dollar. The rate is the amount of quoted currency it will take to acquire one unit of the base currency. It’s going to take 125 U.S. dollars to purchase 100 Euros.
Each country has a 3 letter alphabetic code for currency used in the international market. These are called ISO currency codes. For example, USD stands for the U.S. dollar, GBP stands for the British pound, and JPY stands for the Japanese yen.
How Buying and Selling Works
You take one look at several different prices when you make a trade. Each broker displays two numbers for a currency pair, the bid price and the ask price.
- The Bid Price: This is the price that the broker is willing to buy the base currency at. Now, when you want to sell this pair, it is this price that you will see.
- The Ask Price: This is the selling price to you of the base currency as offered by the broker. You can see this price when you are interested in purchasing the pair.
The difference between these two prices is the spread. Spread is the standard transaction cost for a trade.
Going Long vs. Going Short
You can make money in the forex market whether prices go up or down. What you need to do can be determined by what you would like to achieve in the future.
If you expect the base currency to strengthen against the quote currency, you buy the pair. This is called a long time by traders. The objective is to buy the asset now and then sell it later at a profit.
If you expect the base currency to weaken against the quote currency, you sell the pair. This process is known as short selling or going short. It is possible to sell a pair without having to buy first.
For example, imagine GBP/USD is trading at 1.3200. The buy price is 1.3201 and the sell price is 1.3199. You think the price will go down due to the strengthening U.S. dollar. You open a short position at 1.3199. When the price falls, you would require less dollars to purchase one pound. You can close your trade at a lower price and collect a profit. Otherwise, if the price goes up, you will experience a loss.
The Three Main Categories of Currency Pairs
There are 180 legal currencies worldwide recognized by the United Nations. While this creates many potential combinations, brokers usually offer around 70 currency pairs for trading. They split these pairs into three broad categories:
1. Major Currency Pairs
The major currency pairs are the most traded pairs worldwide. While there are eight major currencies, these currencies form just seven major pairs. Each major pair is required to contain the U.S. dollar on one side.
The seven key pairs of currencies are:
- EUR/USD: Eurozone / United States (Euro dollar)
- USD/JPY: United States / Japan (Dollar yen)
- GBP/USD: United Kingdom / United States (Pound dollar)
- USD/CHF: United States / Switzerland (Dollar swissy)
- AUD/CAD: Australia / Canada (Dollar loonie)
- AUD/USD: Australia-In The United States (Aussie dollar)
- NZD/USD: New Zealand / United States (Kiwi dollar)
Commodity currencies are a favorite group of Forex traders. The Canadian dollar is a great example, as is the Australian dollar. Canada and Australia are big natural resource exporters, so the price of commodities has a direct impact on these currency values.
Majors are the most liquid types in the financial world. Liquidity is a measure of how active a market is. Many active traders trading large botnets at high liquidity represents a level of fluidity. This volume influences the prices frequently, resulting in countless little trades. High liquidity also keeps the transaction spreads very small.
2. Minor Currency Pairs (Crosses)
The minor pairs exclude the U.S. dollar. These pairs are commonly termed market crosses or crosses for short. The most prevalent crosses are among the three primary non-dollar currencies, which are the Euro, the Japanese yen and the British pound.
Some of the typical examples of crosses are as follows:
- Euro Crosses: EUR/CHF (Euro swissy), EUR/GBP (Euro pound), and EUR/AUD (Euro aussie)
- Crosses Yen: EUR/JPY (Euro yen) and GBP/JPY (Pound yen)
- Pound Crosses: GBP/CHF (Pound swissy) and GBP/CAD (Pound loonie)
Crosses are less liquid than the major pairs. But, they are still vibrant markets and provide plenty of trade opportunities. Their spreads tend to be broader than majors, however still very trade-able for a retail trader.
3. Exotic Currency Pairs
An exotic currency pair is a pair that consists of one major currency and one emerging or developing economy currency. These economies include nations like Brazil, Mexico, Singapore, Turkey, and South Africa.
Popular cross pairs are:
- USD/BRL: United States / Brazil (Dollar real)
- USD/SGD: United States / Singapore (Dollar sing)
- USD/ZAR: United States / South Africa (Dollar rand)
- USD/MXN: United States / Mexico (Dollar mex)
Exotic pairs are not heavily traded. Because they have low liquidity, their spreads can be two or three times larger than the spreads of the EUR/USD pair.
Foreign (exotic) currencies are highly volatile to political and economic developments. The exchange rate may go up and down wildly in the event of a sudden election result or national political scandal. This high volatility is something to consider when deciding to trade exotics.
Special Currency Groups to Know
Beyond the three main categories, professional traders group currencies by geographic regions or economic alliances.
The G10 Currencies
The G10 stands for the 10 most-traded and liquid currencies in the world. These assets are freely traded without much impact on their actual underlying forex values. They are the U.S. dollar, Euro, British pound, Japanese yen, Australian dollar, New Zealand dollar, Canadian dollar, the Swiss franc, Norwegian krone, the Swedish krona, and the Danish krone.
The Scandies
Scandinavia consists of a certain subregion in Northern Europe. Denmark, Norway and Sweden have close cultural and economic relations. Together, their currencies are called the Scandies.
The names of these currencies are similar because the word krone and krona is a crown. In the trading world, the Swedish krona (SEK) has the nickname Stockie, while the Norwegian krone (NOK) is called Nokie.
CEE Currencies
CEE is the acronym used to denote Central and Eastern Europe. There are four major CEE currencies in the forex industry. These are the Hungarian forint (HUF), the Czech koruna (CZK), the Polish zloty (PLN) and the Romanian leu (RON).
The Evolving BRICS+ Alliance
Economic blocs change over time, and they deeply affect currency markets. BRIC originally referred to the high growth emerging economies of Brazil, Russia, India and China. Subsequently, South Africa and Indonesia took on membership to make it a group called BRIICS.
The alliance grew significantly to include countries like Egypt, Ethiopia, Iran, Saudi Arabia and the United Arab Emirates. This large group comprises a significant number of people and income worldwide. Given that these countries are seeking ways to trade without traditional methods, monitoring the currencies in these nations is essential for macro traders.
Step-by-Step Guide to Buying and Selling Forex
If you want to start trading currency pairs, you should follow a structured approach to protect your capital.
- Pick Your Trading Method: Determine whether you will prefer trading spot forex or you will trade via a retail broker and using CFDs.
- Open a Trading Account: Select a regulated broker and sign up. Most brokers will allow you to open an account in a matter of minutes, and guarantee that you will not have to put in any money right away.
- Create a Concrete Trading Plan: A trading plan is your own set of rules. It eliminates psychological decision making and uses clearly defined entry and exit limits.
- Choose Your Platform: Download trading software like MT4. Personalise charts, configure custom alerts and know technical tools.
- Analyze the Market: Use fundamental analysis to study economic growth, interest rates, and political events. Analyze historical price patterns and determine critical support and resistance areas through technical analysis.
- Take and Control Your Position: Decide whether to take the buy position or sell position. Enter your trade size, and immediately set up tools to manage your financial risk.
When Is the Best Time to Trade?
In the forex trading market timing is essential. This market is open throughout the day but prices will vary according to the time of day in which local businesses are open. Most traders agree that the best time to buy and sell is when the market is most active. High activity brings high liquidity and high volatility, creating trading opportunities.
For UK and European traders, the market is at its hottest and heaviest immediately after the beginning of the London session at 8 am. The trading volume normally drops off around 10 am UK, during the morning commute rush. Activity picks up again when the American markets open around 12 pm UK time, because the European and US sessions overlap.
3 Popular Forex Trading Strategies
Traders use different strategies to determine when to buy and sell currency pairs. Here are three popular methods.
1. Trend Trading
Trend trading is a medium to long-term strategy. It is a process of searching the trend of the market using technical indicators. Traders rely on helpful resources like the Relatively strong Index (RSI) or moving averages. When the market is making higher highs, it is in a bull market, or uptrend and you want to buy. If it is making lower lows, it is in a downtrend, or a bearish trend, and you look to sell.
2. Trend Reversal Trading
When the price of a currency pair fully reverses, it is known as a trend reversal. For example, a bull run could hit a wall, or a bear run could bottom and start to go up. Among these tools, traders rely on indications like the stochastic oscillator to identify if a pair is overbought or oversold. These extreme readings suggest that the current trend is running out of steam and a reversal is coming.
3. Range Trading
Range trading is effective when a price pair has a definite level resistance within a prolonged range. The price goes up and down with only flirting with the high and lows. A range trader will enter a buy near the bottom and a short sell near the top.
Managing Your Risk in Forex
In Forex trading, you can trade with leverage, meaning that you are able to trade large amounts with little capital. When it comes to leverage, it could make you more profitable, but it could also make you more lossy. For this reason it’s crucial to use an effective threat management approach.
- Set a Risk to Reward Ratio: A trade should never risk more than it can win.
- Use Stop Loss Orders: A stop loss is an automatic order that closes your trade if the market moves against you. It helps keep your overall financial loss to a minimum.
- Maintain Composure: Follow the trading strategy. No chasing losers or trading halts out of anger or excitement.
- Practice with a Demo Account: If you are new to buying and selling currency pairs, start with a simulated account. This allows you to try your luck with virtual money before you commit real money.
FAQs
- What is the most liquid currency pair?
EUR/USD is the most traded and liquid currency pair worldwide. It represents the world’s two largest economic zones.
- Can I trade forex over the weekend?
The standard global forex market closes Friday evening and opens Sunday night. However, some brokers offer specialized weekend trading for select pairs like GBP/USD and EUR/USD.
- What is the difference between a minor pair and an exotic pair?
Similarly, a minor pair is two major currencies, such as EUR/GBP, combined. An exotic pair is a combination of one major currency and one from an emerging market like USD/TRY.
- Why are spreads larger on exotic currency pairs?
Exotic pairs are very low liquid knowing that not many people trade on them. When trading volume is low, the spreads are higher since the risk to the brokers for executing the transaction is higher.
