To achieve success in any field, it is essential to start with a solid understanding of the basics. This principle applies equally to Forex trading, where knowledge of major currency pairs is fundamental. Gaining an understanding of how currency pairs work, especially the major ones, is an important first step in learning to trade Forex online. Fortunately, the basics are straightforward, and the way currency pairs are quoted is consistent across all currencies, from the most frequently traded to the more exotic pairs.
Introduction to Major Forex Pairs
The most widely traded currency pairs are referred to as the majors. Before delving into which pairs are considered major, it's important to understand what a currency pair is. Financial traders aim to profit by speculating on the changing value of an asset, such as a company's stock price or a commodity's worth.
In Forex trading, you speculate on the value of one currency relative to another. When two currencies are paired and valued against each other, they form a currency pair. This relative value is expressed as how many units of the first currency are equivalent to one unit of the second currency. For instance, if the exchange rate of the US dollar to the Japanese yen is 155.00, it means one dollar is worth 155.00 yen. The concept is simple. A practical way to start trading currencies and build an understanding is to use a demo account, which allows you to trade with virtual funds in a risk-free environment before transitioning to a live account.
How to Read Currency Pairs
To learn how to read currency pairs, consider this example: On a trading platform like MT5, you will see various Forex currency pairs listed. Each currency has a three-letter ISO (International Organization for Standardization) symbol, which is straightforward:
- GBP represents the British Pound
- USD represents the US Dollar
- EUR represents the Euro
- JPY represents the Japanese Yen
- CHF represents the Swiss Franc
Suppose you believe the Euro will weaken due to low inflation and potential monetary easing by the European Central Bank (ECB). In the list of currency pairs, you can see the Euro quoted against both the US Dollar and the British Pound. Forex trading allows you to choose which currency you believe the Euro will weaken against the most.
If you anticipate the US Dollar strengthening against the Euro due to the Federal Reserve's tighter monetary policy compared to the ECB's looser stance, you would focus on the EUR/USD pair. The trading platform displays the rates at which you can trade these pairs. The bid price is the rate at which you can sell a currency pair, and the ask price is the rate at which you can buy it. These rates are also known as the 'bid' and 'offer,' or 'sell' and 'buy' prices. The difference between these prices is called the market spread.
Liquidity in Trading Major Forex Currency Pairs
The Forex market is the most liquid market globally, with a few currencies comprising the bulk of the market. The larger the trade volume between two countries, the more liquid their currency pair. The EUR/USD pair is the most liquid in the Forex market, and the most popular pairs are known as the majors.
There is no definitive list of major currency pairs, but typically, the most actively traded pairs include:
- AUD/USD: Australian Dollar vs. US Dollar
- EUR/USD: Euro vs. US Dollar
- GBP/USD: British Pound vs. US Dollar
- USD/CAD: US Dollar vs. Canadian Dollar
- USD/CHF: US Dollar vs. Swiss Franc
- USD/JPY: US Dollar vs. Japanese Yen
These major pairs consist of currencies from the world's largest economies, driven by extensive trade in goods and services. Additionally, the political and economic stability of these nations enhances their currencies' appeal, especially during economic uncertainty.
The US Dollar (USD) is particularly prominent, supported by its status as the preferred reserve currency for central banks worldwide, and because key commodities like oil are priced in USD, necessitating its use in transactions. Following the US Dollar, the Euro is the second most commonly held currency by institutions and governments.
Benefits and Cons of Trading Major Currency Pairs
Trading major currency pairs comes with its own set of advantages and disadvantages. The popularity of these pairs is a significant benefit as it ensures ample availability of news and regular economic updates for their underlying economies. These updates are closely monitored in the market, creating opportunities for sharp price movements that traders can anticipate.
Benefits of Trading Major Currency Pairs
One of the key advantages of major currency pairs is the abundant availability of information. News regarding these pairs is more readily accessible, and there are frequent economic updates from their underlying economies. These updates are closely followed in the market, providing traders with opportunities to capitalise on anticipated price movements.
The tremendous liquidity of major currency pairs offers multiple benefits. High trading volumes drive down transaction costs, allowing these pairs to be traded on much tighter spreads. Greater liquidity also helps smooth out volatility, making the market more predictable. However, even the most liquid currencies can exhibit significant volatility under certain conditions. For example, major economic announcements, like the monthly US employment situation report from the US Bureau of Labor Statistics or the CPI, can significantly impact currency values. Strong payroll growth in this report is often seen as a proxy for overall economic growth, potentially leading to tighter monetary policy by the Federal Reserve and a bullish effect on the US dollar.
Cons of Trading Major Currency Pairs
Trading Forex, including major currency pairs, requires constant attention and regular research. Success in the Forex market involves staying updated on news developments, economic announcements, forecasts, and other relevant data, all while monitoring price fluctuations within chosen currency pairs. Despite the effort, high returns are not guaranteed. For instance, the liquidity of major currency pairs can sometimes smooth out volatility, but extreme price movements can still occur. An example of this is the sharp plunge experienced by the USD/CHF pair in early 2015 when the Swiss National Bank (SNB) abandoned its strategy of capping the Swiss Franc's appreciation.
The inability to receive regular, reliable, and fixed returns as seen with other investment types, such as stocks or bonds, is another potential downside. This variability in returns can be a deterrent for some traders who may not find enough value in Forex trading given the associated risks. However, for others, the potential for substantial short-term gains makes Forex trading appealing despite the risks.
Risk Management and Volatility
Risk management is very important for professional Forex traders to minimise risks. An extreme example of volatility is the dramatic drop in the USD/CHF currency pair after the SNB removed its cap on the Swiss Franc. Such events, although rare, highlight the importance of being prepared for sudden market shifts. Smooth price action is a characteristic of liquid markets, whereas sharp moves are more common in less liquid markets.
Starting with Major Forex Pairs
For those new to Forex trading, starting with major currency pairs is often a good approach. If you have familiarity with a particular economy, you may naturally gravitate toward trading its currency. The benefits of tighter dealing spreads and the availability of economic news and Forex analytics make major currency pairs a solid starting point for many traders.
Trading with a Demo Account
A risk-free way to begin trading Forex is by using a demo trading account. This allows traders to practise without risking their capital and to choose when they wish to transition to live markets. For instance, a demo trading account provides access to real-ti
me market data, the ability to trade with virtual currency, and insights from expert traders, offering a practical way to gain experience before entering the live market. Joining a trading community with experienced traders will also immensely help you on your trading journey.