How do currency pairs work?





Currencies are always quoted in pairs, because every FX trade involves exchanging one currency for another. On the international markets, each currency is represented by a 3-letter (ISO) code. So, for example, EUR for euro, USD for the US dollar, GBP for the pound sterling, JPY for the Japanese yen, and so on.


Currency pairs are usually presented with their currency codes side-by-side (for example, EURUSD represents the euro US dollar currency pair, and EURJPY represents the euro yen currency pair). Sometimes they can be separated by a backslash, a point, colon, or space, but they all refer to the same thing.




Now, the order in which the currencies in a pair are presented is meaningful and is important for you to learn if you're to correctly trade currencies both long and short. The first currency in the pair is known as the base currency, the second one in the pair is called the quote currency.


Base Currency EUR / USD Quote Currency


The exchange rate you see, for example, when viewing the EURUSD pair, basically informs you about how much of the second currency in the pair (the quote currency, or USD in this example), you need in order to purchase a single unit of the first currency in the pair (the base currency, or EUR). 


So, if the exchange rate for EURUSD is quoted as 1.01, that means that $1.01 (a dollar and one cent) is required in order to buy €1 (a single euro). 


When trading currency pairs, you're basically making a call about which of the two currencies in the pair you believe will appreciate against the other. In our example above, if you thought that the euro was due to strengthen against the dollar, you would "buy" or "long" the EURUSD currency pair at $1.01 per euro. If you were correct in your forecast, then that $1.01 exchange rate would rise, for example to $1.04, and when you closed your position, you'd be "selling" those euros back at a higher price, and keeping the profit.


If, on the other hand, your forecast was that the euro would fall against the dollar (in other words, a euro will be worth less than $1.01), you would "sell" or "short" the EURUSD pair at $1.01 per euro. If you were correct in this second instance, then that $1.01 exchange rate would drop, for example to $0.98, and when you closed your trade you'd be "buying" back the euros you sold at $1.01 at a cheaper price, and keeping the profit.




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