Even though currencies are traded on the Forex market, we are not able to buy or sell single currencies. Each time we place a trade in the market we are buying or selling a currency pair.
Currency pairs consist of two currencies – the first one is the base currency and the second one the counter-currency.
An example of a currency pair is the EUR/USD pair.
When we buy the EUR/USD pair, we are actually buying the euro and selling the US dollar.
Similarly, when we sell the EUR/USD pair, we are actually selling the euro and buying the US dollar.
On Forex Markets, you do not actually purchase the currency.
You simply make a prediction: currency X will gain in value over currency Y over a period of time.
Traders make educated guesses by analysing the economy, past trends and major expected events.
This process is called ‘trading forex’. The more technical term is trading Contracts for Difference (CFDs).
Currency Pairs Explained
In general, currency pairs can be grouped into major pairs, cross pair, and exotic pairs.
Major pairs are currency pairs that include the US dollar as either the base currency or counter-currency and one of the other seven major currencies (EUR, CAD, GBP, CHF, JPY, AUD, NZD.)
If you are just beginning with trading, you should focus on the major pairs since they usually offer very low transaction costs and enough liquidity to avoid high slippage. Examples of major pairs are EUR/USD, GBP/USD and USD/CHF.
Cross Pairs & Exotics
Cross pairs, on the other hand, include any two major currencies except the US dollar.
Unlike major pairs, cross pairs have higher transaction costs and, at times of lower liquidity, traders can face slippage.
Cross pairs are also usually more volatile than major pairs. Examples of cross pairs include EUR/GBP, EUR/CHF and AUD/NZD.
Finally, exotic pairs include exotic currencies which are not in the Top 10 of the most traded currencies, such as the Mexican peso, Turkish lira or Czech koruna.
Since those currencies can be extremely volatile, they should be left to be traded by the pros.