Currency Pairs: Types, How They Work, and Real Examples

Ever heard of currency pairs? We can’t really blame you if you did not. And yet, this concept lies at the very foundation of foreign exchange markets, and understanding it is crucial if you want to get involved in trading.

In this article, you will learn about the idea behind currency pairs, how they work, and their types. We’ll have currency pairs explained in detail so you can deal with this integral part of the Forex market.

Currency Pairs: Basic Concept

But before we dive more into the details, let’s start with a simpler question: what are currency pairs? On a basic level, a currency pair is a quotation of two different currencies, where one currency is quoted against the other.

The currencies in such pairs are commonly listed using a slash and an ISO code, for example, USD/EUR. In a pair, the first currency (USD) is called the base currency, while the latter (EUR) is known as the second or quote currency.

Traders use currency pairs to deduce how much of the second currency they need to spend in order to purchase the base currency. Note that talking about buying base currency, we always refer to a single unit. For example, USD/EUR = 0.85 means that you’ll need 0.85 euros to buy 1 US dollar. The same logic applies to all currency pairs, whether widely traded or not.

Understanding How Currency Pairs Work

The first thing to know about currency pairs in the Forex market is that they are traded continuously. The foreign exchange market operates 24/7, five days a week.

Regardless of what pair you want to trade, view it as a single entity. The thing is, when you buy one currency, you automatically sell the other, so there is always a connection between the two.

There are two more terms central to trading pairs: the bid and the ask price. If a broker buys the base currency from you, they pay the bid price. The ask price is the opposite: the price for which the broker will sell you the base currency.

Both prices are not fixed and constantly shift based on numerous factors. This includes everything from geopolitics to economics to many, many other factors. What this means for you as a Forex trader is that risk assessment should become your second nature, as the financial situation can change drastically in a short time.

What Types of Currency Pairs Exist?

Now that you have a basic idea of how to read currency pairs, let’s talk about the types they fall into. All the pairs that are being sold and purchased on exchange markets can be divided into major, minor, and exotic.

Major Currency Pairs

The most popular and frequently traded pairs are called major pairs. Thanks to being traded so often, they have the highest possible level of liquidity. Also, the difference between the currencies in this type of pair is usually small, which is called a tight spread.

To be considered major, a pair needs to include both a US dollar and a currency that trades the most volume against it.

The examples of such pairs include:

• USD/EUR;
• USD/GBP;
• USD/CAD;
• USD/JPY;
• USD/AUD.

When it comes to Australian and Canadian dollars, there is another term used for their pairs with the US dollar — commodity currencies. The reason is that the prices for commodities heavily influence the exchange rates of these pairs.

Minor Currency Pairs

The pairs that do not include a US dollar are referred to as minor pairs. Compared to the major pairings, their liquidity is lower while the spreads are wider. Despite the “minor” moniker, some pairs in this category include strong currencies like GBP and EUR, which often end up being traded the most.

The examples of minor currency pairs include:

• JPY/EUR;
• GBP/CHF.

Exotic Pairs

The least liquid currency pairs are called exotic. Such pairs are traded less frequently compared to major and minor ones. Usually, a pair of this type will include a major currency and one from a smaller economy. As you can imagine, because of the nature of such combinations, the spreads you can expect to see are far wider than for the previous two categories.

Some pairs that can be considered exotic include:

• EUR/ZAR;
• USD/MXN.

Currency Pairs in Action: Reviewed

Now that we’ve talked about the theory behind currency pairs, let’s take a look at how they operate in real life. Here are a few frequently traded pairs and what you should know about them.

USD/EUR

This pairing is the cornerstone of the global exchange market, as it is traded frequently and in high volumes. Any economic changes, inflation, or instability both in Europe and the USA lead to shifts in prices. The USD/EUR pair is characterized by high liquidity and is the focus of attention for all traders and financial experts because of its global impact.

CAD/USD

Another interesting pair is the Canadian Dollar and the US dollar. As CAD is a commodity currency, any changes in the prices of commodities (particularly oil) will affect its rates. For this reason, traders focus on it when changes in commodity costs are on the horizon. Other factors that lead to price shifts in the pair include employment rates, interest rates, and more.

EUR/JPY

An example of a pair that doesn’t include the US dollar but still involves major currencies, it is the pairing of the Euro and the Japanese Yen. Similar to other pairs, any political and economic changes in Japan or Europe will lead to price fluctuations. Often referred to as a safe-haven currency, JPY tends to rise in price during times of global uncertainty. The reason is simple — a lot of investors buy it to reduce the risks.

Final Thought

Understanding currency pairs is one of the first steps to take if you want to dive into the forex market. At the core of each pair is a base and secondary currency, and the price fluctuations between the two allow traders to make a profit. All pairs are divided into major, minor, and exotic based on the volumes being traded. As a trader, it’s your job to choose which currencies to trade based on your analysis of the market situation.

If you are new to trading, a good tip is to choose currencies that are associated with lower volatility. For example, major pairs are less volatile compared to minor or exotic ones, as the latter are prone to sudden price changes. While you can gain more from these fluctuations, the risk is usually not worth it for beginners.