Currency Pairs Selling Their Personalities

Posted 06/05/2009, 9:00 am EST by Grace Cheng from tradingmarkets.com

Forex (Foreign Exchange) simply refers to the buying of one currency and selling of another at the same time. The forex market is the largest financial market in the world, even bigger than stock markets. Its daily turnover exceeds $3 trillion. The forex market is a global network of buyers and sellers of currencies, and is done over-the-counter (OTC), which means that there is no central exchange and clearinghouse where orders are matched. Forex trading takes place 24 hours a day, five and a half days a week, unlike stock markets which have specified opening and closing times for trading.

Almost all currencies can be traded through a forex broker . Currencies are represented by three letters, where the first two letters stand for the name of the country and the third stands for the name of the currency. Some of the most traded currencies are: the US dollar (USD), the Euro (EUR), the Japanese yen (JPY), the British pound (GBP), the Swiss franc (CHF), the Canadian Dollar (CAD) and the Australian Dollar (AUD). A currency always goes up or down in value in relation to another currency. For example, when you simply say the US dollar is going down, it doesn't make much sense because the US dollar could be going up against the Australian dollar but down against the Euro. Hence currencies are always traded in pairs, and are quoted in a manner like this: EUR/USD. The first currency in the pair is called the base currency and the second is called the counter or quote currency. The four most traded currency pairs are known as majors and they are:

EUR/USD

USD/CHF

GBP/USD

USD/JPY

As you can see from these pairs, the Euro, Swiss franc, British pound and Japanese yen are traded against the US dollar. As each pair has its own personality, it is essential for you to learn a bit more about each one, and understand the factors influencing their movements,

EUR/USD

The most recent 2007 Bank for International Settlements (BIS) survey shows that the most traded major currency pair is the EUR/USD with 27% of total daily volume. The EUR/USD is a great pair to trade for both new and seasoned currency traders. It is a very active pair with moderate volatility, which attracts traders to it like bees to honey. Its movements are quite smooth and there is enough action for day and short-term traders to capture meaningful profits.

EUR/USD tends to be negatively correlated to the USD/CHF and positively to the GBP/USD. What this means is that if EUR/USD goes up, then most likely USD/CHF will go down. This close relationship can be seen even on an intraday basis. In fact, this negative correlation is the closest relationship in the forex markets. You can take advantage of this relationship by opening both the EUR/USD and USD/CHF charts in your trading software, and compare both together. This way, you can have a better idea of where either pair could be moving next.

When you trade this pair, you need to be concerned with the bigger economic picture of both the Eurozone and the United States, and keep up with what monetary policymakers are saying about their country's economy and their domestic currency. The Federal Reserve (Fed) is the central bank of the United States and its current chairman is Ben Bernanke. The European Central Bank (ECB) is in charge of monetary policy for the the Euro, and its president is Jean-Claude Trichet.

USD/CHF

The 2007 BIS survey shows that trading of the USD/CHF constitutes only 5% of total daily volume, which makes it the least traded among the majors. Its bid/ask spread is usually wider than that of EUR/USD as a result, but don't let that stop you from trading this pair. It is still a popularly traded pair and its movements are negatively correlated to that of EUR/USD. Sometimes USD/CHF leads the movement of EUR/USD, other times it's the other way around. In general, the Swiss franc usually benefits from financial market or geopolitical turmoil as it is seen as a safe-haven currency.

USD/CHF tends to be influenced more by US fundamentals rather than economic and monetary happenings in Switzerland. The central bank of Switzerland is the Swiss National Bank (SNB) and its chairman is Jean-Pierre Roth. Switzerland relies heavily on export, like Japan and the Eurozone.

GBP/USD

GBP/USD, nicknamed Cable, is the third most liquid currency pair, according to the 2007 BIS survey, making up 12% of daily market turnover in the forex market. This pair is notorious for its wild and ultra-volatile movements, and is certainly not for the new trader. Price breakouts tend to be false and it is easy for new traders to get whipsawed by market noise. The British pound tends to move in the same direction as EUR/USD although that is not always the case. As the pound has a relatively high interest attached to it, it is seen as a high-yield currency.

The Bank of England (BOE) is the central bank of the United Kingdom, and Mervyn King is the governor. A series of interest rate hikes by the BOE in late 2006 and 2007 led the British pound to rise to the highest rate against the Euro in 2007.

USD/JPY

USD/JPY is the second most traded currency pair, with 13% of total daily volume according to the 2007 BIS survey. This currency pair is most actively traded during the Asian session, and has a tight bid/ask spread most of the time. Its movements are smooth and the pair reacts quickly to the risk environment in the financial markets. In times of risk aversion, the yen tends to strengthen against other currencies as global investors close out their carry trades.

The Bank of Japan (BOJ) is the central bank. Since Japan is highly dependent on exports, the BOJ has a strong interest in keeping the yen low compared to other currencies. On several occasions in the past, the BOJ has physically intervened in the forex market by selling the yen against US dollars and Euros, thus artificially weakening its currency for the sake of its export industry.

Summary

Each currency pair has its own characteristics and is influenced by different factors. It is important for a trader or investor to understand these characteristics and to trade or invest accordingly. You may find that one of them suits your own trading or investing style better, and in that case, just focus on what you think is best for you. There is always a currency pair out there among the hundreds which will catch your fancy and meet your goals.