How The Currency Markets Work
Financial trading is big business, whether that is investing in actual stocks and assets or executing some form of derivative trading such as binary options where you are predicting the outcome of assets. The largest market of them all is the currency (or Forex) market which is a firm favourite with many.
Currency trading is one of the oldest methods of trading in existence and today is the largest and most liquid market in the world. With roots that can be traced back 2,500 years ago, the evolvement of technology and a hunger to make money has only served to make this an even more popular method of investing than it has ever been with millions of pounds invested daily.
How do you know which pairs to buy and how exactly does this form of trading work? For you to become successful, there is much to learn and much to consider. That said, when done wisely, you can make lots of money from currency pairs or Forex trading as it is more commonly known.
In this guide, you will learn:
- A brief history and overview of currency trading
- The difference in major, minors and exotics
- About the most popular currencies and pairs
What is a Currency Pair
As the name might suggest, it is a pair of currencies where one is the 'base' unit and one the 'quote'. They are marked in value against each other so as an example the USD (United States dollar) has a specific value against the GBP (British pound). One of these currencies is the quote currency with the other being the base.
You can choose to predict the outcome of the USD against the GBP where the USD is the base currency or the other way around, GBP/USD, where the GBP becomes the base unit. Each is assigned an ISO code as a means of being represented on the markets. The United States dollar becomes the USD, EUR the euro, GBP the Great British pound etc.
They are referred to by their ISO codes and listed on stock markets around the world. The minors tend to be those that don’t involve the USD – the EUR/GBP, for example, is classed as a minor pair with the GBP/ZAR (South African Rand) graded as an exotic or emerging pair.
There are approximately 180 legal currencies in existence so you could pair one with 179 others. The most you will find offered by a broker tends to be between 40-70.
Currency trading began 2,500 years ago when the Greeks and Egyptians measured fortune by the weight of their silver and gold coins.
Brief History of Currency Pairs
Currency trading began 2,500 years ago when the Greeks and Egyptians measured fortune by the weight of their silver and gold coins. During the Roman empire, when minting was centralised, a more regulated system came into force. It was during the Middle Ages when copper became a favoured minting metal and, because it was cheaper, the possibility of producing lower value coins became a reality.
Like so many other assets including commodities and stocks, it was on the Amsterdam Stock Exchange (the first of its kind) that the primary currency trading market evolved around 500 years ago. Like other assets, it was then replicated around the globe on stock exchanges the value of individual currencies started to stabilise the exchange rates.
Moving forward to the 19th century and the Gold Standard was introduced to ensure that only enough money to cover the gold reserves was in circulation. It was after the First World War when more money needed to be printed that the Gold Standard was no longer sustainable.
Through the 20th-century Forex trading grew in popularity, more markets introduced it, more currency pairs added to exchanges and now it is the largest financial trading market in the world.
The Popular Currency Pairs
Major currency pairs are by far the most popular with the USD being the most actively traded in the world. A listed currency must be strong economically and politically. The top eight traded currencies are the United States dollar (USD), euro (EUR), British pound (GBP), Canadian dollar (CAD), Swiss Franc (CHF), New Zealand dollar (NZD), Australian dollar (AUD) and Japanese YEN (JPY).
If you were to calculate the different pairs that could be traded from these eight currencies alone, you would get 27 different possibilities. That said, there is only a certain number that is usually quoted by brokers due to their liquidity.
The significant pairs are often easier to predict, follow and more familiar to everyone. They can also be very volatile to market news, global news, individual countries politics and other situations which can affect the prices of a particular country.
How Currency Pairs Are Traded
Trading of these pairs is conducted on the foreign exchange (Forex) markets and is the largest and most liquid market in the world. Forex trading is big business, and many traders invest thousands and thousands of dollars in this activity. Essentially when dealing in currency pairs, you are making the simultaneous purchase of one unit and the sale of another.
When it comes to binary options, you can predict how the assets will perform and which will finish higher by the point of expiry without purchasing it. The expiry time could be anything from 30/60 seconds to a few weeks.
Forex history tells us there is big money to be made from FX trading, and you will each have your individual preferences. Some of you may prefer the most active pairs while others will prefer the minors. Many people like to try their hand at the emerging or exotics which are less popular but can make good returns.
Jacob has been an author for us since our launch in 2012. He has over forty years’ experience in the financial sector and has held a variety of positions within financial services corporations and venture capitalist organisations. Learn more.