Currency Pair Overview

To help an investor understand the basic terminology in the Forex spot market it is useful to consider an individual currency pair as a financial instrument (similar to a share of stock) which can either be bought or sold. Just as shares of General Electric trade under the ticker symbol GE, GBP/USD would be the "symbol identifier" for the GBP/USD currency pair.

The first currency in the pair is referred to as the base currency and the second currency is the counter or quote currency. The U.S. Dollar, as the world′s dominant currency, is usually considered the base currency. Typical pairs that are often traded include USD/JPY, USD/CHF and USD/CAD. In these examples the quotes are expressed as a unit of 1 USD per the second currency quoted in the pair. The exceptions are the Euro, Great Britain pound, and Australian dollar. These currencies are quoted as dollars per foreign currency.

Ignoring the concept of bid and ask for the moment, consider the following example of the exchange rate between the US Dollar and Swiss Franc:

    USD/CHF = 1.1614

The currency to the left of the slash ("/") is called the base currency (in this example, the US Dollar) and the one to the right is called the counter/quote currency (in this example, the Swiss Franc). This notation means that 1 Dollar (1 unit of the base currency) is equal to 1.1614 Swiss Francs (counter/quote currency). If an investor believes the Dollar will appreciate against the Swiss Franc, the investor would purchase Dollars and sell Swiss Francs. The exchange rate specifies how much you have to pay in units of the counter/quote currency to buy one unit of the base currency; in the above example, the investor would exchange 1.1614 Swiss Francs for 1 US Dollar. Conversely, if an investor believes the Dollar will depreciate against the Swiss Franc the investor would purchase Swiss Francs and sell Dollars; i.e. exchange 1 US Dollar for 1.1614 Swiss Francs.

Establishing a currency pair position by placing a trade in an online forex trading platform by purchasing USD/CHF would be considered long the US Dollar and short the Swiss Franc. Conversely, selling USD/CHF would be considered short the US Dollar and long the Swiss Franc.

Similar to equities, Forex price quotes include a "bid" and an "ask" offered by a market maker. The forex market maker is a bank or brokerage company that stands ready, every second of the trading day with a firm bid and ask price. This is a positive for the investor because when the investor chooses to buy and sell a pair of currencies, the market maker will purchase from and sell to the investor, even if they do not have a buyer and seller lined up. In doing so, they are literally "making a market" for the currencies.

The "bid" is the price at which a market maker is willing to buy the base currency in exchange for the counter/quote currency. The "ask" is the price at which a market maker will sell the base currency in exchange for the counter/quote currency. The "bid" price will always be lower than the "ask" price. The difference between the "bid" and the "ask" price is referred to as the spread.

Currencies are quoted out four decimal places with the last placeholder called a point or a pip. In Forex, like any "bid/ask" traded instrument, there is an immediate cost in establishing a position. For example, USD/CHF may quote a "bid" at 1.1614 and "ask" at 1.1617; this three-pip spread represents the investor′s cost for opening or closing a position for 1 lot of USD/CHF. On an online forex trading system, a USD/CHF quote may be listed as: 1.1614/17. One exception to exchange rates quoted out four decimal places is the Japanese yen (JPY) which is quoted out to two decimal places.
 

Currency pairs are traded in lots, which refers to the standard unit size of a transaction. Typically, one standard lot is equal to 100,000 units of the base currency, 10,000 units for a mini lot and 1000 units for a micro lot.

There are many different forms of currency available to trade however, 85% of all daily transactions involve trading a group of currencies referred to as the "Majors". The Majors include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar. The four most actively traded currency pairs are USD/JPY, EUR/USD, GBP/USD, and USD/CHF. The major currency pairs offer increased trading opportunities due to greater liquidity and tight spreads.

• EUR is always positioned as a base currency
• GBP is always positioned as a base currency except when paired with EUR
• JPY is always positioned as a counter/quote currency

Cross rates are an exchange rate between two non-U.S.-Dollar currencies. Popular cross rate currency pairs include EUR/GBP, EUR/JPY and AUD/CAD. Cross rates are expressed as parity between two currencies, based on a rate of these currencies in relation to a third currency. For example: EUR/CHF = (USD/CHF) * (EUR/USD)