Currency Pairs Guide: What are they & How Do They Work?
Currency pairs pit two currencies against each other, creating opportunities for traders to potentially profit from their price movements. Read our forex market guide to understand how they work, key categories to trade and much more.
Knowing how currency pairs work and the key types available will guide your trade calls and help in building a diverse portfolio. Ready to dive in? Below, we'll take you through:
- What is a currency pair?
- How currency pairs work
- How to read currency pairs
- What are the types of currency pairs?
- Major currency pairs
- Cross-currency pairs
- Minor currency pairs
- Exotic currency pairs
- Commodity currency pairs
- Regional currency pairs
- How many currency pairs are there?
- What are the most liquid currency pairs?
- What are the most volatile currency pairs?
- How to choose a currency pair to trade
What is a currency pair?
A currency pair is a grouping of two currencies in which the value of one is relative to the other. The foreign exchange market, also known as forex, revolves around the buying, selling and speculation of currency pairs. Currency prices fluctuate relative to each other, moving constantly throughout the 24-hour trading day based on supply and demand.
How currency pairs work
Each currency is given a three-letter code – usually based on the country and currency name – by the International Organization for Standardization (ISO). For example, the British pound and US dollar pair is displayed as GBP/USD.
The currency on the left of the pair is called the base currency, while the currency on the right is the quote or variable currency. A currency pair quote shows how much of the quote currency you'll need to buy one unit of the base currency at that exact point in time.
The two ways a currency pair can move in price are:
- The base currency strengthens or weakens relative to the quote.
- The quote currency strengthens or weakens relative to the base.
An important point to note when trading currency pairs is that a pair itself is a single unit. When you buy one from a forex broker like Tradu, you're buying the base currency and selling the quote. The opposite applies when you sell a currency pair. This is different to stock trading, for example, where the values of stocks are independent of each other.
How to read currency pairs
Brokers will always quote two prices for a currency pair: the bid and ask. This terminology is from the broker's perspective; as a trader, you buy currency at the ask price and sell at the bid price.
The price to buy a currency is usually more than the price to sell, with this difference called the spread. Brokers receive the spread for executing the trade. Spreads tend to be tighter for major currency pairs, as we'll explain below.
Direct vs indirect forex quotes
Quotes are usually displayed with your home currency in mind, known as a direct quote. So if you reside in Great Britain and want to buy US dollars, your pair would read USD/GBP and show the cost of one US dollar in British pounds. An indirect quote is the inverse.
Familiarise yourself with more key terms like these in our trading glossary.
What are the types of currency pairs?
There are several classifications of currency pairs based on the currencies they include.
Major currency pairs
Major currency pairs always include the US dollar. Majors are the most traded and most liquid pairs, with relatively low volatility in comparison to other categories. Examples of major currency pairs include:
- EUR/USD (Euro and US dollar)
- USD/JPY (US dollar and Japanese Yen)
- GBP/USD (British pound and US dollar)
- AUD/USD (Australian dollar and US dollar)
- USD/CHF (US dollar and Swiss franc)
Cross-currency pairs
A cross-currency pair, also known as a cross, is simply any pair that doesn't include the US dollar, such as:
- AUD/NZD (Australian dollar and New Zealand dollar)
- AUD/CAD (Australian dollar and Canadian dollar)
- AUD/CHF (Australian dollar and Swiss franc)
- NZD/CAD (New Zealand dollar and Canadian dollar)
- NZD/CHF (New Zealand dollar and Swiss franc)
Crosses are generally less liquid than majors but still present opportunities, albeit with wider spreads. The most liquid crosses are minor pairs…
Minor currency pairs
Minor pairs are cross-currency pairs that therefore don't include the US dollar but feature one of the other three major currencies: the Euro, British pound and Japanese yen. They're sometimes confused for crosses, but minor pairs are only a defined portion of crosses.
Examples include:
- EUR/GBP (Euro and British pound)
- EUR/AUD (Euro and Australian dollar)
- EUR/CAD (Euro and Canadian dollar)
- GBP/NZD (British pound and New Zealand dollar)
- GBP/CAD (British pound and Canadian dollar)
- GBP/CHF (British pound and Swiss franc)
- JPY/EUR (Japanese yen and Euro)
- JPY/GBP (Japanese yen and British pound)
- JPY/AUD (Japanese yen and Australian dollar)
Exotic currency pairs
Exotic currency pairs tend to combine major or significant currencies with those from emerging markets. These pairs are generally the least liquid, with the widest spreads and highest price volatility. Examples include:
- EUR/HUF (Euro and Hungarian forint)
- EUR/TRY (Euro and Turkish lira)
- USD/ZAR (US dollar and South African rand)
- USD/SEK (US dollar and Swedish Krona)
- USD/RUB (US dollar and Russian rouble)
Commodity currency pairs
Commodity currency pairs include so-called commodity currencies, hailing from economies that rely on exports. The Canadian, Australian and New Zealand dollars are primary examples:
- The Canadian dollar is closely tied to the price of oil.
- The Australian dollar is strongly linked to iron, coal, uranium and gold markets, as well as agricultural products.
- The New Zealand dollar is heavily influenced by agricultural commodities.
Significant commodity currency pairs are:
- USD/CAD (US dollar and Canadian dollar)
- AUD/USD (Australian dollar and US dollar)
- NZD/USD (New Zealand dollar and US dollar)
Regional currency pairs
A lesser-considered category of currency pairs is regional pairs. These are simply pairs including currencies from two nations of the same geographic region, for example:
- NOK/SEK (Norwegian krone and Swedish krona)
- AUD/NZD (Australian dollar and New Zealand dollar)
- BRL/ARS (Brazilian real and Argentine peso)
How many currency pairs are there?
As we've only begun to cover above, there are lots of different currency pairs available. The exact number is tied to the currencies in existence and changes as they come and go around the world. The characteristics and subsequent popularity of currency pairs with traders can vary greatly, however.
What are the most liquid currency pairs?
Liquidity refers to how active a market is both in terms of the number of traders actively trading it and the volumes they're trading. While liquidity fluctuates all the time, major currency pairs tend to be the most popular. This is in part thanks to their relative pricing stability, ease of analysis and tighter spreads, which increase profit margins however, might result in unexpected losses too.
According to the Bank of International Settlements (BIS), the five most liquid currency pairs as of April 2022 were:
- USD/EUR (US dollar and Euro)
- USD/JPY (US dollar and Japanese yen)
- USD/GBP (US dollar and British pound)
- USD/EME (US dollar and emerging market economies excluding the Chinese renminbi and Russian rouble)
- USD/CNY (US dollar and Chinese renminbi)
What are the most volatile currency pairs?
While stable pairs come with less risk, you need some degree of price movement to create the potential for profit. And the price movements of volatile pairs tend to be more dramatic, leading to larger profits or losses. This can appeal to more risk-tolerant traders.
There are lots of factors that can drive volatility, all of which can influence different currencies at different times. As such, it's difficult to say which pairs are most volatile at the time of reading. But certain pairs have shown high volatility historically:
- AUD/JPY (Australian dollar and Japanese yen)
- NZD/JPY (New Zealand dollar and Japanese yen)
- GBP/AUD (British pound and Australian dollar)
- USD/ZAR (US dollar and South African rand)
- USD/MXN (US dollar and Mexican peso)
Volatile pairs are typically less liquid due to their inherent risk, leading to larger spreads. Emerging market currencies usually come with higher volatility and less liquidity than major currencies. Analysing and predicting their movements can prove more difficult as a result.
How to choose a currency pair to trade
Ultimately, the right currency pairs for you will depend on factors like your trading objectives, risk tolerance and current portfolio. Sound fundamental and technical analysis should also shape your trades. But certain considerations can help guide your choices:
- Volatility: As we've mentioned, some pairs are more prone to volatility than others, and volatility can hit different pairs at different times. But you need some price movement to profit, so monitor the news and price action at the time, factoring in the risk they create.
- Liquidity: Highly liquid pairs tend to have tighter spreads – expenses going to the broker – and vice versa, impacting your cost of trading.
- Time of activity: Different currency pairs usually have times of day when they're most actively traded, creating larger volumes and more potential for price movements. This can be due to domestic release times for news that affects either currency's value.
Another point to consider when choosing multiple currency pairs to trade is currency correlation.
What is currency correlation?
Currency pair correlation describes the similarities shared by multiple pairs:
- If pairs are positively correlated, their prices are likely to move in the same direction and by similar amounts.
- If pairs are negatively correlated, their prices are likely to move in opposite directions by similar amounts.
- If pairs have no correlation, their prices are likely to move relatively randomly.
Few currency pairs are traded independently of others. Understanding this dynamic when researching and trading multiple pairs can help balance your portfolio.
Start trading and keep learning with Tradu
With hundreds of currency pairs to choose from in the biggest financial market in the world, the opportunities are almost endless. You can trade a number of currency pairs with Tradu, from major to cross, minor, exotic and commodity.
Comfortable with currency pairs? Broaden your knowledge with our other forex market guides.