Understanding Currency Pairs

As spread betters continue to learn about the broad diversity of assets that is available for trading, we have seen a massive rise in the popularity of currency trades.  Financial trading is not just about stocks anymore, so it is a good idea to have an understanding of how different asset classes operate.  Currency crosses have some differences when compared to stocks and commodities because the value of one currency is always expressed in terms of its relationship to another currency.  In other words, a currency has no intrinsic value.  Any definable value will always depend on the secondary currency in the cross.

Reading A Forex Quote

The currency market is also referred to as the foreign exchange market, or forex.  Each asset is sectioned off in a series of forex pairs, with some of the most popular examples seen in the EUR/USD, GBP/USD, USD/JPY, AUD/USD, USD/CAD, and USD/CHF.  There are literally thousands of different forex pairs that spread betters are able to trade, but the majority of positions are taken these majors (roughly 85%).  The higher liquidity levels associated with these pairs means they tend to encounter less volatility when compared to the more exotic currencies.

Currency Crosses and Exotic Pairs

Currency crosses do not contain the US Dollar, and instead match two of the other majors against one another.  Common examples here include EUR/CHF or AUD/NZD.  Exotic pairs are those that combine one of the major currencies and an emerging markets currency.  Examples here include choices like USD/SGD and the EUR/ZAR, which pair a major with the Singapore Dollar and the South African Rand.  This is by no means an exhaustive list of all the currency choices available but this is the way currency pairs are categorized in active spread betting.

Chart Example:  EUR/USD

 

Let’s start with a chart example in the EUR/USD.

Euro

What information can be seen in the chart above?  Since the Euro is the first currency in the pair (the base currency) and the Dollar is the second (the counter currency), any upside moves in the chart would should strengthen in the Euro and weakness in the Dollar.  The reverse would be true for downside moves on the chart.

Euro

The chart shows the Euro valued at just under 1.25 per Dollar.  We can see that prices rising steadily through May of 2014, only to fall sharply in the following months.  This means that the Euro was in control until roughly the middle of 2014 but then started to show significant weakness shortly thereafter. 

 

Understanding Your Positions And Maximizing Gains

 

Before any forex positions are taken, spread betters must understand that you are simultaneously buying one currency and selling another.  This means that your outlook is positive (bullish) for one of the currencies and negative (bearish) on the other.   Going long (buying) the EUR/USD suggests a positive stance on the Euro and a negative stance in the Dollar.  Going short (selling) the EUR/USD suggests a positive stance on the Dollar and a negative stance in the Euro.

 

The biggest profits can be made when traders are able to successfully match the strongest and weakest currencies against one another.  So if you were highly bullish on the Euro but only slightly bearish on the Dollar, it would make sense to avoid buying the EUR/USD and instead choose a pair that contains the Euro and a currency with a more bearish outlook.   It is true that you do not necessarily need to match the strongest and weakest currencies in order to make profits (you simply need to be accurate in your expectations for the relative performance of both currencies in your position).  But for those looking to maximize gains and take your spread betting profits to the next level, it is a good idea to watch for scenarios where the strongest and weakest currencies can be traded against one another.