If you’ve ever heard your forex trader or anyone in the finance department talk about “counter currencies”, “majors” or even more specifically “EUR/USD” pairs then it is quite likely that they are talking in forex speak about currency pairs. In this article we have a brief look at the formulation of a currency pair, how they are used and the most widely used currency pairs.
A currency pair is another way of looking at exchange rates between two different currencies. Two currencies are used to give a ratio of value based on the conversion of one currency into the other. They are comprised of two parts – the base currency and the counter currency – but there is no better way of exploring this than looking at an example!
EUR/USD 1.240
Above you will see the currency pair known as the “Fibre”. More on why it is called a fibre later..! Firstly we can see that there are two currencies involved – the Euro and the American Dollar. The above pretty much says the following:
“1 unit of the base currency Euro will get you 1.24 units of the counter currency USD”
Pretty simple! The base currency is the Euro and the counter currency is the American dollar. When we trade 1 Euro we expect to get 1.24 dollars based on the ratio/quotation. If the quote changes to 1.26 then the Euro has increased in relative value. If the quote drops to 1.22 then the Euro has slipped in value.
Whilst the concept is simple the formulation of currency pairs still falls to quite a stringent structure. There are rules for forming a currency pair although they are more an established priority list rather than set by a body or organisation. Historically they were the result of ranking according to relative value with respect to one another however the introduction of the Euro changed the formulation. In 1999 the European Central Bank ensured that the Euro would have first precedence as a base currency when used in a currency pair. As such the priority list goes a little something like this…
euro
pound sterling
Australian dollar
New Zealand dollar
United States dollar
Canadian dollar
Swiss franc
Japanese Yen
Usually currency pairs are created in a hierarchical order – for example when talking about the rate between the USD and Canadian dollar you would use the following: USD/CAD 1.04. Or if looking for a pair of Australian dollar to British pound you would use GBP/AUD 1.59. The base currency is dictated by the hierarchy. The most widely used currency pairs are known as “Majors” and include the following currency pairs.
EUR/USD
EUR/USD
GBP/USD
AUD/USD
USD/CHF
Other currencies (the Minors) are generally quoted against one of the major currencies. Currency pairs that do not involve the USD are known as cross currency pairs with the exception of Euro pairs which are known as Euro Crosses.
By now I’m sure you are thinking about how to use these new found pairs in general conversation or shock horror in a trade conversation. There are three additional terms to think about – the spot rate (usually the rate of exchange based on the pair for that given moment in time), the spread and the pip. The spread and the pip are terms used by the forex trader. During a trade a currency is often offered at a sale price or “ask price” – the trader then puts in a “bid” price based which they hope is lower than the ask. The difference between the two rates is known as “the spread” and the quantity is known as a “pip”. If the pair quote for GBP/USD is 1.5709 at the bid rate but 1.5704 then the spread is 0.0005 GBP or 5 pips. Ideally you want to get as many pips as possible. Trading in large quantities is thus important when making money from trades but can obviously present some associated risks! Unsurprisingly a “bureau de change” makes their money from exchanges like this by ensuring the spread is wide.
So why is EUR/USD called a “fibre”? Some say that “fibre” probably follows the trend of other currency pair nicknames like the GBP/USD’s “cable” moniker. Cable was derived from the way in which data was transferred between the two countries (i.e. a huge cable under the Atlantic Ocean that synchronized the GBP/USD quote). It is quite possible that fibre reflects the fibre optic age of communications.
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