Currency Pairs - The Jargon and Terminology That You Need To Know
Now that you have had some form of introduction into the world of Forex trading, it is time to learn a bit more about the most important aspects of this type of trading, the currency pairs themselves.
You wouldn’t start a card game without knowing how many cards are in the deck and the same goes for trading. You need to know what sort of hands you can use to make some nice profits or leverage to reach your desired result.
Knowing the ins and outs of each currency, as well as how they affect one another when paired gives you the information needed to be able to execute effective trades.
How are Currencies Quoted?
When it comes to the Forex market, every currency has a friend. They are paired together in order to come up with an effective price.
The value of a given currency is its rate and this is found by comparing it with this other currency.
The first currency that you see listed is usually called the base currency, while the second leg of the pair is known as the quote currency.
When these two components have been put together, the amount of the quote currency is how much you need to pay to get a single unit of the base currency.
Different Types of Currency Pairs
Usually when you are comparing different currencies to one another, the more popular ones will be at the top of the pile.
The normal order of priority is as follows: Euro (EUR), British Pound (GBP) Australian Dollar (AUD), New Zealand Dollar (NZD), US Dollar (USD) and so on.
For example, with the EUR/USD pair, this will translate in real world terms as how many US Dollars can be used to purchase one euro.
Obviously certain currency pairs are going to be traded more than others. It is similar to sports in so far as people tend to support teams that are in the top divisions rather than those in the lower leagues.
While it is not an exact science when it comes to pointing out the exact global rankings, this list is pretty accurate:
Having said all this, the currency pair that is far and wide more popular than any other one is EUR/USD when you look at the trading volume completed on a daily basis.
There are more regional currencies available on the market to trade with, but they usually do not have the same sort of attention when it comes to Forex trading.
Short term traders are usually going to place more of a focus on currency pairs that are highly traded as there is enough activity in the short term that allows them to take advantage in quick price changes.
Those traders who want to focus more on long term position and swing trades will not be too concerned with those currency pairs that are highly traded as short term movements is going to be evened out over time.
What are Spreads?
When you get a quote for a currency pair, there are going to be two key prices that this is going to be made up of; the bid and the ask price. The difference between the two is known as the ‘Spread.’
The spread is effectively the profit that the bank or broker will make to allow you to execute the trade (the cost of your transaction).
The greater the spread is, it will be pricier for you to make the trade while obviously the opposite is true for a tighter spread.
The more frequently traded and larger currencies will have narrow spreads and the currencies that are not commonly used will have a wider spread.
When you are short term focused, the spread is going to play a large role in what trades you make, as you are going to be frequently making trades which can rack up the transaction costs very quickly.
Longer term traders need not worry too much about this as they are not going to be trading as frequently.
What are Pips?
Some of the terms that a lot of first time Forex traders don’t fully understand is pips.
A pip is a number value that is used in all forms of financial trading and investing.
As we are looking at the Forex market it particular, we say that the value of a currency that is provided is in the form of pips. A single pip is 0.0001.
This is the absolute smallest change in price that can be made with an exchange rate. Usually you will see currency pairs that have been priced four numbers following the decimal point.
Therefore if you are looking at a 5 pip spread for EUR/USD it will be in the form of 1.2530/1.2535.
Currency Appreciation / Depreciation
When you are looking at currency appreciation, this is when the value of a certain currency increases compared to another.
There are a number of different reasons why this may occur, such as changes in interest rates, government policies, business cycles and trade balances.
While normal stocks have their price as the representative of their value, currencies relay on comparing one currency with another to get a rate of value.
Currency depreciation is when the shoe is on the other foot, the value of one currency decreases when compared to the other currency.
Hopefully you will now be on good terms when it comes to the various key pieces of jargon that are associated with Forex trading. These are all key concepts that need to be understood before you dive head first into your trading account.
Just like with anything, when you build a solid foundation of knowledge and information, your long term results in this subject matter inevitably will be better. This will allow us to move onto the different types of trading analysis.