Choosing a trading instrument: how to trade currency pairs
Early on the path to becoming a trader, every beginner must determine what to trade and how. This choice should be made based on the desired goals, the available budget, and personal preferences. To help you compare the aspects of main groups of trading instruments, we are launching a new series of articles on choosing trading instruments. Let’s start with one of the most popular options — trading currency pairs.
What is a currency pair
A currency pair is the ratio of prices of two currencies. The term is often used in relation to Forex trading, where a trader always sells one currency when buying another. The first currency in the pair is called the base currency, and the second is the quote currency.
Where to trade currency pairs
Currency pairs are traded on the previously mentioned foreign exchange market — Forex. The uniqueness of this platform lies in its decentralization. Quotes are formed under the direct influence of traders themselves. Forex is a kind of exchange office where currencies are purchased and put up for sale at their respective values.
How to trade currency pairs on Forex?
The system is pretty simple. For example, what do they mean when they say that the currency pair EUR/USD has a value of 1.2040? You have 100 euros and you want to understand how many US dollars you can buy with this money. You need to multiply 100 by 1.2040. The answer is 120.4. That is how much US dollars you can buy for 100 euros at this rate.
What affects exchange rates
First, macroeconomic data has a great impact on currency rates. A Forex trader should always keep track of international economic news and current statistics: changes in the political arena, the results of central bank meetings, the latest employment data, inflation rate, etc. Also, the degree of the central bank’s involvement in the local economy, as well as the general market sentiment can cause significant fluctuations in quotations. Without fundamental analysis and constant monitoring of this data, your chance for a successful trade goes to zero. There are special macroeconomic calendars that make it much easier for traders to navigate in the large flow of information. They present the most significant events that can seriously affect the quotes.
Another indispensable assistant of a Forex trader is technical analysis. Technical analysis works with the price chart of currency pairs. The ground rules here are the same as when trading on the stock market. Wave analysis, indicators, and chart patterns should be your best helpers and decision makers.
To further improve your results, we recommend using a combination of fundamental analysis of important economic events and technical analysis of price charts.
What you need to know before starting to trade currency pairs
1. All operations that deal with the difference in rates are conducted with the use of margin. This means that each trade is carried out only on condition of the subsequent reverse operation. If you buy an asset, you must sell it in the future. Currency doesn’t become your personal property, it’s not at your disposal. What the trader has is only the difference between price of buying and selling.
2. Another important distinction of currency pair trading is the time of transactions. Often it depends on the opening hours of large financial centers. A day in the Forex market is divided into different sessions. Experienced traders know that it’s better opening and closing trades in the American and European sessions, while Asian session will be less profitable, and the Pacific session will probably bring you almost no profit. At the forefront of the Asian session are Tokyo, Hong Kong, and Singapore. The most successful time for trading currency pairs in this session is from 11PM–12:00AM to 8AM–9AM (UTC). The highlights of the European session are Frankfurt, Zurich, Paris, London. Here, the most successful time is 7AM–8AM 4PM–5PM. And, finally, the recommended time for the most profitable American session is from 1PM–2PM to 10–11PM. Some traders also pay attention to the best days to trade currency, usually such days are Tuesday and Wednesday.
3. When choosing currency pairs as a trading instrument, you should also keep in mind that they often have much greater volatility than stocks.
How to choose a currency pair
The most demanded currency on the market is the US dollar (USD). It participates in the most transactions. The prices of other currencies are expressed in relation to USD. The ratio of the currency of any country to the US dollar is called a direct quote. And the ratio of the US dollar to other local currencies is called an indirect quote. Combinations without the US dollar are called cross rates.
The most popular pair for trading is EUR/USD. It accounts for about 70% of all transactions made on the foreign exchange market. Many traders have been trading only EUR/USD for years and made significant profits. Why is EUR/USD the most popular currency pair? Because both currencies in this combination are in demand all over the world, they are actively traded, the volumes of currencies are high, and the spreads are minimal, the current rate is available around the clock.
Combinations of the yen (JPY), the pound sterling (GBP), the Swiss franc (CHF), the euro (EUR), the Canadian dollar (CAD), and the Australian dollar (AUD) are also in great demand (about 85%). These pairs are the main pairs on Forex, since they are the most profitable and safest choice for trading. Also, due to their great popularity, they have the highest liquidity and the tightest spreads.
Along with the major pairs, there are also so-called exotic pairs — combinations of rare local currencies. They are particularly volatile and unpredictable. Operations with such assets can bring serious profits, but they carry high risks.
Volatility is the range of price changes in a certain (most often daily) period. Some currency pairs are highly volatile, such as GBP/JPY and GBP/USD. Trading them is very risky, and it should only be done by professional traders with a special trading strategy designed for strong price fluctuations. The pairs EUR/AUD, EUR/CAD are slightly less volatile. EUR/USD, USD/CHF, USD/JPY come next. These are the pairs used by the most traders due to the absence of sharp swings in their prices. The most steady currency pairs are EUR/GBP, EUR/CHF. Fluctuations in their quotations are 3–5 times lower than in those of major currency pairs.
So, to trade or not to trade, that is the question. The answer is up to you. In this article, we have covered the main aspects of trading currency pairs in Forex. In the following articles in this series, we’ll talk about other popular instruments so that you can make your own decision and choose the suitable assets for your trading.
