Decoding Forex Quotes: A Comprehensive Guide to Understanding Currency Pairs

What is currency pairs?

A currency pair is a combination of two currencies used for trading in the foreign exchange market. It consists of two parts: base currency and quote currency. The base currency is the first currency in the pair, and the quote currency is the last currency in the pair. Currency pairs are usually quoted in terms of the base currency representing the value of the quote currency. For example, for the EUR/USD currency pair, EUR is the base currency and USD is the quote currency. This indicates how much 1 EUR is worth in US dollars. A major currency pair refers to the most important and most commonly traded currency pair in the world, usually involving the U.S. dollar as one of the currencies. 

Minor currency pairs are currency pairs other than major currency pairs. They usually don't involve the U.S. dollar, but include combinations between other major currencies. Here are some examples of minor currency pairs:

- EUR/GBP: Euro to British Pound

- AUD/CAD: Australian dollar to Canadian dollar

- NZD/JPY: New Zealand Dollar to Japanese Yen

A foreign currency pair is any currency pair that does not include a domestic currency. For example, for an American investor, currency pairs other than majors and minors, such as CAD/JPY (Canadian dollar to Japanese yen) or EUR/AUD (Euro to Australian dollar), are Foreign currency pairs.

Major currency pairs

The major currency pairs are the most active and liquid currency pairs in the foreign exchange market. They usually involve the currency of the world's largest economy (the U.S. dollar) as one of the currencies. Here are the most commonly traded major currency pairs in the world:

- EUR/USD: Euro against U.S. dollar

- GBP/USD: British pound to U.S. dollar

- USD/JPY: US dollar against Japanese yen

- USD/CHF: U.S. dollar to Swiss franc

Additionally, there are several currency pairs that are also widely traded:

- CAD/USD: Canadian dollar to U.S. dollar

- AUD/USD: Australian dollar to U.S. dollar

- NZD/USD: New Zealand dollar to U.S. dollar

Major currency pairs are characterized by high liquidity and volume, low spreads, and a wealth of trading and analysis tools. Due to their wide range of participants and market depth, major currency pairs typically offer high price stability and predictability and are a constant focus of investors and traders.

Know the exchange rate

An exchange rate is the relative value of one currency to another. It expresses how many units of one currency can be exchanged for another currency. The fluctuation of the exchange rate is determined by market supply and demand, so it will constantly change.

The spot exchange rate refers to the exchange rate used when conducting foreign exchange transactions in real time. This is the prevailing real-time exchange rate in the market and is used to actually buy or sell currency. The forward exchange rate refers to the exchange rate stipulated when conducting foreign exchange transactions on a certain date in the future. It is entered into now, but the delivery date is at a specified date in the future. Forward exchange rates are often used for risk hedging or protection against currency fluctuations.

There are two main ways to determine the exchange rate:

1. Floating exchange rate system: Under the floating exchange rate system, the exchange rate is determined by the relationship between supply and demand in the market, that is, the fluctuation of the exchange rate is determined according to the demand and supply of buying and selling currencies in the foreign exchange market.

2. Fixed exchange rate system: Under a fixed exchange rate system, the exchange rate is set at a fixed value by the government or the central bank, and the exchange rate is maintained by intervening in the market.

There are many factors that affect exchange rates, some of the main ones include:

- Interest rate: Interest rate is an important factor in guiding capital flow. High interest rates generally attract foreign investors, increasing demand for the currency, which in turn boosts the exchange rate. For example, FOREX.com raised the Hong Kong dollar currency pair margin interest rate in March

- Economic indicators: Economic indicators such as GDP, inflation rate, employment data, etc. have an important impact on the exchange rate. Good economic performance usually increases the demand for the currency, pushing the exchange rate higher.

- Geopolitical events: Geopolitical events such as wars, political turmoil, etc. can cause market tension, and investors may be cautious about related currencies, putting pressure on exchange rates.

- Trade Balance: A trade surplus means that a country exports more than it imports, increasing the demand for that country's currency and possibly boosting the exchange rate.

- Foreign Investment Flows: Foreign investment has a significant impact on a country's economy and may increase the demand for the country's currency, thereby affecting the exchange rate.

It should be noted that the exchange rate is affected by a variety of factors, so it is a dynamic concept that is constantly changing. It is very important for participants in the foreign exchange market to understand the impact of these factors on the exchange rate in a timely manner.

The components of foreign exchange quotation:

Bid and Ask: Forex quotes usually consist of a bid and an ask. The bid price is the price at which a market participant buys a currency, while the ask price is the price at which a market participant sells a currency. Buying prices are usually higher and selling prices are lower because market participants need to pay the difference as transaction costs.

Spreads and Points: A spread in Forex is the difference in price between the bid price and the ask price. This is due to factors such as transaction costs for market makers and traders, liquidity changes, etc. Express the price difference as a pip, the smallest unit of change in the exchange rate. Usually, the point calculation is a continuous change, such as 0.0001 or 0.01.

Calculation of profit and loss based on changes in exchange rates: Forex trading profit and loss calculations are based on changes in exchange rates. If you buy a currency pair and the exchange rate rises, you will make a profit. Conversely, if you buy a currency pair and the exchange rate falls, you will lose money. The calculation of profit and loss depends on the size of your position and the magnitude of the exchange rate movement.

Cross Currency Pairs and Foreign Currency Pairs

A cross currency pair is a trading pair between two currencies that do not contain the U.S. dollar. These currency pairs are usually created by combining them with USD currency pairs. Cross currency pairs also have a certain amount of liquidity and trading volume in the foreign exchange market, especially in the time period when trading with major currency pairs. The price of a cross currency pair is usually determined by the relative value between the two currencies.

Here are some examples of common currency crosses:

- EUR/GBP: Euro to British Pound

- EUR/JPY: Euro against Japanese Yen

- GBP/JPY: British Pound to Japanese Yen

- AUD/JPY: Australian dollar to Japanese yen

A foreign currency pair is a trading pair of two currencies that are not domestic. For example, for a U.S. investor, trading with the Australian dollar against the Canadian dollar (AUD/CAD) would be a foreign currency pair. Foreign currency pairs generally have lower liquidity and trading volumes than majors and crosses.

In forex trading, crosses and foreign currency pairs may not get as much attention as major currency pairs, but they still provide investors with a variety of trading opportunities. For those traders who have a deeper understanding of specific currency pairs and regional economies, cross currency pairs and foreign currency pairs may offer more trading opportunities and potential profits.

Read foreign exchange quotes

Reading foreign exchange quotes requires an understanding of the following steps:

1. Determine the base currency and the quote currency: In a currency pair, identifying the base currency and the quote currency is the first step. The base currency is the first currency in the pair, and the quote currency is the last currency in the pair.

2. Understand buying and selling prices: Forex quotes usually consist of buying and selling prices. The bid price is the price at which a market participant buys a currency, while the ask price is the price at which a market participant sells a currency.

3. Interpreting quotes: Quotes are given in the form of relative values, representing the ratio of the base currency to the quote currency. For example, for the EUR/USD currency pair, a quote of 1.1000 means that 1 Euro is exchanged for 1.1000 USD.

4. Understand the decimal point of the quotation: Usually, the foreign exchange quotation uses the decimal point to represent the smallest unit of change, called a point. For example, if the quote rises from 1.1000 to 1.1001, it means that the exchange rate has increased by one pip.

Examples and explanations of quotes for different currency pairs:

- EUR/USD = 1.1000: 1 Euro can be exchanged for 1.1000 USD.

- GBP/JPY = 130.50: 1 British pound can be exchanged for 130.50 Japanese yen.

- USD/CAD = 1.2500: 1 US dollar can be exchanged for 1.2500 Canadian dollars.

Different quotation conventions: direct quotation and indirect quotation.

- Direct Quote: A direct quote refers to a quote in which the quote currency is used as the base currency. For example, EUR/USD = 1.1000, meaning that 1 Euro can be exchanged for 1.1000 USD. Most major currency pairs are quoted directly.

- Indirect quotes: Indirect quotes are quotes where the base currency is used as the quote currency. For example, USD/JPY = 110.00, meaning that 1 US dollar can be exchanged for 110.00 Japanese yen. Certain currency pairs use indirect quotes, such as the Japanese Yen's quotes against other major currencies.

Currency pair correlation

There is a certain relationship and correlation between currency pairs due to market factors and economic factors.

- Positive Correlation: A positive correlation refers to a similar trend between two currency pairs. When one currency pair rises, the other tends to rise; when one currency pair falls, the other also tends to fall. For example, EUR/USD and GBP/USD usually show a positive correlation.

- Negative Correlation: Negative correlation refers to the opposite trend between two currency pairs. When one currency pair rises, the other tends to fall; when one currency pair falls, the other tends to rise. For example, USD/JPY and EUR/USD typically show a negative correlation.

Currency pair correlation is critical to risk management. Understanding the correlation between currency pairs can help traders make better decisions in terms of risk management and position diversification. If a trader holds two highly correlated currency pairs at the same time, it may increase the concentration risk of the portfolio. Therefore, the correlation between currency pairs should be considered when developing a trading strategy and risk management plan.

Understanding how to decode forex quotes and interpret currency pairs is critical to successful forex trading. By mastering the fundamentals of exchange rates and foreign exchange quotes, traders can make informed decisions and effectively navigate the complexities of the foreign exchange market. Remember, continuous learning and staying abreast of market trends is critical to success in the ever-changing world of forex trading.