Pipruit: Yesterday, I remember seeing something like this:
| Currency | We Buy at | We Sell at |
|---|---|---|
| 1 EUR | 1.35 USD | 1.37 USD |
| 1 GBP | 1.65 USD | 1.67 USD |
Commander in Pips: For simplicity, let’s skip separate quoting for buy and sell (we will talk about it a bit later), and use just the first column - what does it mean?
| Currency | USD |
|---|---|
| 1 EUR | 1.35 |
| 1 GBP | 1.65 |
Pipruit: Oh, it’s quite simple – I can exchange 1 GBP for 1.65 USD and 1 EUR for 1.35 USD
Pipruit: When you’re explaining that, I have an association with pair of scales. On the one scale is the first currency, say EUR, on the other one is USD. And exchanging rate, i.e. equilibrium is fluctuating all the time, based on which currency is getting stronger right now.
Commander in Pips: Outstanding! That’s an excellent association. I see that you’re starting to have a real knack for all this stuff.
Now to your second question about “all possible pairs”. Here are three currencies – GBP, USD and EUR. How many pairs can you create with them?
Pipruit: Let’s see… we already know pairs like USD/USD or EUR/EUR do not make any sense, so I suppose that we can create only three pairs – EUR/USD, GBP/USD and EUR/GBP. Also we can make reverse pairs, such as USD/EUR, for example, but this will be the same pair as EUR/USD. The only difference will be that it will show how many Euros I should pay for 1 buck, instead of initially how much bucks I should pay for 1 EUR. If, for example EUR/USD rate is 1.35, then USD/EUR is 1/1.35 or about 0.74. It means that I should pay about 0.74 EUR for 1 buck.
Commander in Pips: Very good! Indeed, FOREX does not have both EUR/USD and USD/EUR pairs simultaneously. This is because they are, in fact, identical. Ok, let’s add one more currency, say, CAD. What pairs can you create now?
Pipruit: It’s a simple task. I just have to add just pairs that include CAD. EUR/USD, GBP/USD and EUR/GBP we have already, so I need to add USD/CAD, EUR/CAD and GBP/CAD.
Pipruit: Yes sir, now it looks clear. But how many pairs exist in total? And are there any differences with trading them?
Commander in Pips: There are a lot of pairs. Generally speaking, all pairs can be put into one of three groups – Majors, Crosses and Exotic.
Pipruit: Yes, we’ve talked about Majors previously. They are USD, EUR, GBP, CAD, JPY, AUD and NZD.
Commander in Pips: Not quite. We’ve talked about “Major currencies” and now we’re discussing “Major pairs”. It’s not exactly the same.
- Pipruit: What’s the difference, sir?
Commander in Pips:
- All major pairs include the US Dollar with another “Major currency”. These have a leading share in total turnover on the FOREX market. Here they are:
Pair Countries EUR/USD Euro zone / United States GBP/USD United Kingdom / United States USD/CHF United States/ Switzerland USD/JPY United States / Japan USD/CAD United States / Canada AUD/USD Australia / United States NZD/USD New Zealand / United States - Crosses are other combinations of “Major Currencies”. They include one major currency with another, but not with the US Dollar. You can construct them by yourself. I’ll just give you some examples. Euro crosses:
Pair Countries EUR/GBP Euro zone / United States EUR/CHF Euro zone / Switzerland EUR/CAD Euro zone / Canada EUR/AUD Euro zone / Australia EUR/NZD Euro zone / New Zealand - or Japanese Yen crosses:
PairCountries EUR/JPY Euro zone / Japan GBP/JPY United Kingdom / Japan CHF/JPY Switzerland / Japan USD/JPY United States / Japan CAD/JPY Canada / Japan AUD/JPY Australia / Japan NZD/JPY New Zealand / Japan
Pipruit: Ok, Ok, I think I understand that.
Commander in Pips: During recent times, the economies of emerging markets have becomes stronger, the trading turnover is rising, so on FOREX markets, there is more demand appeared for exchanging emerging market’s currencies as between themselves and with major currencies. For example, now we can trade on FOREX such currencies as Brazilian real, South Africa’s rand, Mexican peso, Thai baht, Russian Ruble, Singaporean dollar, Chinese Yuan, etc. Usually they are traded to US Dollar and sometimes with other major currencies. Occasionally, they are traded with each other. There is much will depend from your FOREX broker, because not all of them provide the possibility to trade exotic pairs or even their crosses. But, in general, these pairs exist and can be traded. Here are some examples of them:Pipruit: And what are exotic pairs?
Pair Countries USD/HKD United States (dollar)/ Hong Kong (dollar) USD/SGD United States (dollar) / Singapore (dollar) USD/ZAR United States (dollar) / South Africa (rand) USD/THB United States (dollar) / Thailand (baht) USD/MXN United States (dollar) / Mexico (peso) USD/DKK United States (dollar) / Denmark (Krone) USD/SEK United States (dollar) / Sweden (Kronor) USD/NOK United States (dollar) / Norway (Krone)
Due to lower size on economies of Emerging markets and their international Trade turnover, the trading volumes with exotic pairs is lower compared to majors and crosses. Besides, the transaction cost for trading them is usually higher. - All major pairs include the US Dollar with another “Major currency”. These have a leading share in total turnover on the FOREX market. Here they are:
Pipruit: I understand about pairs, but what are transaction costs?
Commander in Pips: Well, it’s a bit early to talk about that in detail, but I give you fast forward look. Let’s return to quote board in exchange centre:
| Currency | We Buy at | We Sell at |
|---|---|---|
| 1 EUR | 1.35 USD | 1.37 USD |
| 1 GBP | 1.65 USD | 1.67 USD |
See – there is a double quoting, one price is for buying the foreign currency and another for selling it. The difference between buy and sell price calls “bid/ask spread”. If you will buy Euro here for 1.37 (because bank sells Euro for 1.37 currently, this is “Ask” price) and at once sell it at 1.35 (because bank buys Euro only for 1.35, this is “Bid” price) you will get a $0.02 loss – that’s your transaction cost. In fact, you do nothing, because you stand with the same position - you Buy Euro and Sell Euro at the same time. Even so, you’ve just lost 2 cents. So, for major pairs the Bid/Ask spread on FOREX is very tight - usually 0.0001-0.0003, but for exotic pairs it’s much wider. It means that if you would like to make the same transaction with Thai baht, for example, you can get greater loss instead of 2 cents as it stands with Euro transaction. It can be 50 cents or even buck. You should remember that if you ever intend to trade exotic pairs. We’ve just talked about Bid/Ask spread but there are other sorts of transaction costs that exist also.
In general remember one simple rule – “the higher the transaction costs, the lower your potential profit from the trade”.
EUR/GBP Euro zone / United States
should be:
EUR/GBP Euro zone / United Kingdom