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| forex articles » Currency pairs, types of pairs, PIPS and what drives price fluctuations |
| Currency pairs, types of pairs, PIPS and what drives price fluctuations |
How is Forex traded?
When you decide to trade Forex it's important for you to learn some of the basic mechanics of Forex trading. Currency trading takes place in pairs, profits and losses are measured in pips and numerous factors drive price fluctuations in foreign exchange market. In this article we will take a look at the major currency pairs, define pips and outline some of the major factors that drive price fluctuations in the Forex market
Currency pairs
Currency trading takes place in pairs. The currency pair represents the exchange rate between two currencies. For example EUR/USD represents the number of US Dollars one Euro can purchase .All Forex trades involve the simultaneous buying one currency and selling of another. The first currency is the “base currency” and the second currency is the “quote currency.” If you buy a currency pair, you buy the base currency and sell the quote currency. The bid (buy price) represents how much of the quote currency is needed for you to get one unit of the base currency. Conversely, when you sell the currency pair, you sell the base currency and receive the quote currency. The ask (sell price) for the currency pair represents how much you will get in the quote currency for selling one unit of base currency.
Price quotation
The value of a currency is determined by comparison to another currency. When you buy a currency pair you are buying the base currency and selling the quote currency. When you sell a currency pair you’re are selling the base currency and buying the quote currency.
Example:
USD/EUR =0.7692
This currency quotation represents a currency pair of USD and the EUR. The base currency (USD) is always at 1 and the quote currency (EUR) shows how much it costs to buy one unit of the base currency. In this example one USD costs 0.7692 euros.
EUR/USD=1.3000
This currency quotation represents a currency pair of EUR/ USD. It costs 1.3000 USD to buy 1 EUR.
The currency pair can be thought of as a single unit that can be bought or sold.
Although currency pairs involve two separate currencies, the pair trading itself is considered a single unit. For example, each currency pair represents its own trade. A single currency can be gaining against one currency and losing at the same time to another. EUR/USD can be trading lower against EUR/CHF at the same time gaining in value against the Swiss Franc. In other words, the EUR can be losing value against the dollar the same time gaining against the Swiss Franc. The ability to sell a currency pair gives you the opportunity to profit from a rising or falling market
Types of pairs
The currency pairs listed below represent about 80% of all trades in Forex markets.
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| US Dollar |
USD |
| Euro |
EUR |
| British Pound |
GBP |
| Japanese Yen |
JPY |
| Swiss Franc |
CHF |
| Canadian Dollar |
CAD |
| Australian Dollar |
AUD |
| New Zealand Dollar |
NZD |
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Currency Pair Terminology |
| Euro Dollar |
EUR/USD |
| Cable |
GBP/USD |
| Swissy |
USD/CHF |
| Loonie |
USD/CAD |
| Dollar Yen |
USD/JPY |
| Aussie Dollar |
AUD/USD |
| Kiwi Dollar |
AUD/USD |
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Pips
The money that you are earning or losing in Forex is called a Pip. Pip is one unit of price change in the bid/ask price of a currency. It is the last digit in a rate; the fourth decimal place in an exchange rate. Pip stands for percentage in point and is the minimal incremental change in value a currency pair can make. Typically, the quote for a pair is stated to four decimal places. If the EUR/USD moved from 1.3075 to 1.3080, it would have moved by 5 pips. Not all pips are calculated equally. The pip value in the base currency is the USD is equal to $10, the value included in GBP is worth one sterling and pip in the Canadian dollar is worth one Canadian Dollar.
What drives price fluctuations in the Forex market?
In future articles will go into much greater detail of what drives price fluctuations in the Forex market but let's take a look at some of the major factors that may influence the direction of Forex market.
Economic /geopolitics / supply demand
The main factors that drive foreign exchange price fluctuations can be complex and tend to vary over time. Macro economic indicators, geo-political risks and supply and demand for money are the major factors that generally influence price fluctuations in foreign exchange market.
Macro economic indicators?
Forex prices are influenced by the economic and political factors facing nations that are involved in the currency you are trading. The most important factors that influence the Forex market fluctuation are inflation and interest rates and political stability. The US dollar makes up about 90% of transactions on the Forex markets, because of this information about the US economy and economic data released by the US government can have major impact on the foreign exchange trade. Listed below are some of the major US economic reports that can move foreign exchange markets.
- Interest-rate decisions
- GDP
- Unemployment data
- Inflation: CPI
- Retail sales
- Consumer confidence surveys
- Business confidence surveys
- Manufacturing confidence surveys
- The trade balance
Interest rate differential
Interest-rate differential is a major influence on the price fluctuations in the Forex markets. Generally a currency with a higher rate of return will appreciate against a lower yielding currency.
Growth differential
Growth different and political landscape must also be taken into consideration. Higher yield may not support a currency growth is slowing and the government of the currency is unstable.
News
One of the biggest factors that move prices in the foreign exchange market is news. The news includes information on current events and geopolitics.
Economic calendar
Another key mover of foreign exchange markets is the economic calendar. Currency traders are constantly monitoring economic data releases from countries all over the world.
Supply and demand
Supply and demand factors in the foreign exchange market are often difficult to assess. For example the recent shortage of US dollars needed by foreign central banks during the height of the credit crisis created demand this for US dollars and sparked a sharp USD rally Another example, is recent investor flows generated by yield differential creating demand for high-yield currencies and Yen carry trade.
International trade flows
Speculative flows
Speculative flows also can move foreign exchange markets. Foreign exchange markets tend to trend. Forex trends often represent speculative buying or selling of a currency based on overall market sentiment.
Intervention
Intervention can also influence for change markets. Intervention by central banks can produce temporary wide fluctuations in foreign exchange markets. Central banks have been less active over the recent years but the threat of intervention is a major tool that central banks will use to try to influence the direction of currency
Psychology
Psychology is a very important factor in investment decisions and movements in financial markets are often driven by crowd psychology. Human emotions (fear greed faith and hope) play a major role in price movements in Forex,
Actions of professional traders and fund managers investing for large pools of money
Technicals
Fundamental analysis of Forex markets is complex and this makes many traders rely on technical analysis to try to determine price direction of currency markets. Currency markets are often driven by the influence of technical analysis and chart patterns.
Summary
In upcoming articles will go into much greater detail of the mechanics of foreign exchange trading and the factors that make currency prices move. The Easy- Forex trading platform is a great place to start familiarizing yourself with how currency pairs are quoted and the type of resources the platform makes available for you to become a successful trader.
Test your knowledge
- True or false.
The currency pair represents the exchange rate between two currencies.
- Unlike many online trading platforms, there's no need for software downloads of any kind with Easy Forex
- base
- home
- first
- True or false.
Pip stands for percentage in point and is the minimal incremental change in value a currency pair can make.
- At Easy-Forex you can use your credit card to make the necessary deposits or margin requirements for your trade.
- inflation rates, interest rates and political stability
- Intervention, forex brokers, futures traders
- leverage, margin, weather
Answer key
- True
- a, base
- True
- a, inflation, interest rates, political stability
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