Currencies are traded in pairs
Forex trading is the simultaneous purchase of one currency and the sale of another. Currencies are traded through a broker or dealer, and are traded in pairs; For example the Euro and the US Dollar (EUR/USD) or the British Pound and the Japanese Yen (GBP/JPY).
When you trade the forex market, you buy or sell currency pairs.
Imagine all the pairs constantly in a “tug of war” with each coin on its own side of the rope. Exchange rates change based on the strongest currency at the moment.
Major currency pairs
The following currency pairs are known as “major pairs”. All of these pairs have the US Dollar (USD) on one side and are the most traded. The major currencies are the most liquid and most traded currency pairs in the world: EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, AUD/USD and NZD/USD.
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Major currency pairs or minor currency pairs
Currency pairs that do not include the US dollar (USD) are known as cross currency pairs or simply “cross pairs”. The main crosses are also known as “Palace”. The most actively traded pairs contain three major currencies other than the US dollar: the euro, the Japanese yen, and the British pound.
Some of the euro pairs are: EUR/CHF, EUR/GBP, EUR/CAD, EUR/AUD and EUR/NZD.
Here are the crosses for the yen as they use the Japanese yen on one side: EUR/JPY, GBP/JPY, CHF/JPY, CAD/JPY, AUD/JPY, and NZD/JPY.
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Just like Europe, Great Britain has its own crosses too: GBP/CHF, GBP/AUD, GBP/CAD, and GBP/NZD.
Here are some other currency pairs that are small: AUD/CHF, AUD/CAD, AUD/NZD, CAD/CHF, NZD/CHF, and NZD/CAD.
Exotic pairs consist of one major currency linked to the currency of an emerging economy, such as Brazil, Mexico or Hungary. Here are some examples of exotic currency pairs: USD/HKD, USD/SGD, USD/ZAR, USD/THB, USD/MXN, USD/DKK, USD/SEK, and USD/NOK.
It is not uncommon to have two or three times larger spreads than the EUR/USD or USD/JPY spreads so, if you want to trade exotic pairs, remember to keep this in mind in your decision.
Since the foreign exchange market is so exceptional, traders have come up with a few different ways to invest in currencies. Among these, the most popular are the spot forex market, futures contracts, options, and exchange-traded funds (or ETFs).
In the spot market, currencies are traded instantly or “on the spot” using the current market price. What’s great about this market is the small spreads and 24 hour runs. It is very easy to participate in this market as accounts can be opened with a simple investment of up to $25! Most brokers usually provide charts, news and other information for free.
Futures contracts are contracts to buy or sell a specific asset for a certain fee at a date in the future. That’s why they are called futures contracts! Forex futures contracts were designed by the Chicago Mercantile Exchange (CME) as long ago as 1972. As futures contracts have certain parameters and are traded through a central exchange, the market is very transparent and well regulated. This means that the price and transaction details are readily available.
An “option” is a financial instrument that gives the buyer the ability, or option, but not the obligation, to buy or sell an investment at a specified price on the date the option is completed. If a trader “sells” an option, they will be happy to order or sell an asset for a set fee on the completion date.
Just like futures, options are also traded on an exchange, such as the Chicago Board Options Exchange, the International Securities Exchange, or the Philadelphia Stock Exchange. But the drawback of forex options trading is that the market hours are limited for certain options and the liquidity is not as great as the futures market or the spot market.
Exchange Traded Funds
Exchange-traded funds or ETFs are the newest members of the foreign exchange market. An ETF can contain a range of stocks with some currencies, allowing a trader to diversify with other assets. They are produced by financial institutions and can be traded like stocks through an exchange. Like forex options, the limitation in trading ETFs is that the market is not available for all hours. Also, since ETFs contain shares, they are subject to trading commissions and additional transaction fees.