Currency pairs are the fundamentals of the foreign exchange space because every investment in this market is centred around them. Considering there are about 195 countries in the world and over 100 pairs available for investors, and each of these pairs has its pros and cons, it is a lot to take in. To build a healthy portfolio as a forex trader, you need to be grounded enough in the classes of these currencies and how they could make or mar your investments. This article will help you with that.
Currency pairs: A detailed overview
The name “currency pair” already explains itself: a set of two different currencies with their value being quoted against each other. This term is often used to compare the value of one against the other in the forex market, giving investors an idea of how they are both performing. It answers the question of how much of one is needed to purchase the other.
It is common knowledge that the forex market revolves around the buying and selling of different currencies. When traders buy a pair, they get the base currency in exchange for the quoted currency. The bid price indicates how much of the quote is needed to obtain one unit of the base.
Take AUD/USD, for instance, with AUD being the base and USD being the quoted currency. If the current exchange rate for AUD/USD is 0.7500, this means one Australian dollar is equal to 0.75 US dollars. If you believe the Australian Dollar will strengthen against the US Dollar, you might decide to buy the AUD/USD pair. If you buy 1000 AUD, you’ll pay 750 USD. If the rate rises at some point to 0.78, your 1000 AUD will be worth 780 USD. This is the basics of how buying and selling currencies for profits works.
Types of currency pairs
Currency pairs are classified into several groups based on their liquidity and level of volatility.
Major currency pairs
Some of the most common sets you’ve heard of likely fall into this category. They are often the most traded and easily accessible for market investors, and this is a result of their high liquidity. Major pairs consist of options like EUR/USD, USD/JPY, and AUD/USD. This category of asset class also tends to be less volatile than others because the pairs backed by some of the world’s strongest economies. EUR/USD, for instance, is backed by the United States and Europe. Aside from the lesser volatility and access to liquidity, the forex trading broker often offers tight spreads, which could help boost profitability for traders. When the spread is tight, investors can open and close a position with lesser costs and also maximise their profit potential. Some other major sets to consider adding to your portfolio are GBP/USD, USD/CHT, and USD/CAD.
Minor currency pairs
This category comprises sets that do not include the US Dollar, like GBP/JPY, EUR/CHF, and EUR/GBP. Minors are not as liquid as the majors, and so come with a wider spread and high costs in transactions. The lesser liquidity also makes it slightly more difficult for investors to get in and out of the market. These factors explain why the minor category is not as traded as majors and is not the first choice for many investors. One advantage, however, is that it could be great for diversifying into other economies outside the US dollar and possibly evading some losses tied to the United States’ economic news.
Exotic pairs
Exotic pairs are a category that takes one currency from a developing country and presents it against one from a major economy. For instance, USD/SGD. That is the US Dollar and the Singapore Dollar. These sets don’t see heavyweight trading like the majors do and come with a lower liquidity. Sometimes, locating instant buyers and sellers requires some patience. The spreads for these categories of assets are also wider, increasing the costs of transactions. And although this asset class is volatile, it presents the possibility for high reward. Examples of options in this category are USD/TRY, EUR/TRY, and EUR/THB.
Striking a balance
The basics of currency trading is understanding each of these asset classes and how they might benefit your portfolio. Each pair has its personality, and your choices should ideally mirror your long-term investment plans. If you’re less of a risk taker, go for major pairs since they are more reassuring, especially in terms of economic stability. Minor and exotic sets could be used as support and for the purpose of diversification. Prioritise major currencies with stable economies and try to strike a balance by including other options, as this could help reduce exposure to risk.
Images: Supplied
This is a sponsored article produced in partnership with Bazoom