Currency Pairs

The following is a list of the most frequently traded currencies, their trading symbols, their nicknames and major characteristics:

USD (US Dollar)

The US Dollar is by far the most transacted currency in the world. This is due to several factors as you have already learned in the last chapter. First, it's the world's primary reserve currency, which makes this currency highly susceptible to changes in interest rates. Second, the USD is a universal measure to evaluate any other currency as well as many commodities such as oil (hence the term "petrodollar") and gold.

Today's other major currencies like the Euro, the British Pound, the Australian Dollar and New Zealand Dollar are moving against the American currency, and so do the Japanese Yen, the Swiss franc and Canadian Dollar.

70% of the U.S economy depends on domestic consumption, making its currency very susceptible to data on employment and consumption. Any contraction in the labor market has a negative effect on this currency.

All US Dollar denominated bank deposits held at foreign banks or foreign branches of American banks are known as "Eurodollars". Some economists maintain that the overseas demand for Dollars allows the United States to maintain persistent trade deficits without causing the value of the currency to depreciate and the flow of trade to readjust. Other economists believe that at some stage in the future these pressures will precipitate a run against the US Dollar with serious global financial consequences.

Nickname: Buck or Greenback

 

EUR (Euro)

The European Monetary Union is the world's second largest economical power. The Euro is the currency shared by all the constituting countries which also share a single monetary policy dictated by the European Central Bank (ECB).

This currency is both a trade driven and a capital flow driven economy. Before the establishment of the Euro, central banks didn't accumulate large amounts of every single European national currency, but with the introduction of the Euro it is now reasonable to diversify the foreign reserves with the single currency. This increasing acceptance as a reserve currency makes the Euro also very susceptible to changes in interest rates.
The effect of the Euro competing with the Dollar for the role of reserve currency is misleading. It gives observers the impression that a rise in the value of the Euro versus the US Dollar is the effect of increased global strength of the Euro, while it may be the effect of an intrinsic weakening of the Dollar itself.

Nickname: Fiber or Single Currency

 

JPY (Japanese Yen)

The Japanese Yen, despite belonging to the third most important single economy, has a much smaller international presence than the Dollar or the Euro. The Yen is characterized by being a relatively liquid currency 24 hours.

Since much of the Eastern economy moves according to Japan, the Yen is quite sensitive to factors related to Asian stock exchanges. Because of the interest rate differential between this currency and other major currencies that preponderated for several years, it is also sensitive to any change affecting the so-called "Carry Trade". Investors were then shifting capital away from Japan in order to earn higher yields. However, in times of financial crisis when risk tolerance increases, the Yen is not used to fund carry trades and is punished accordingly. When volatility surges to dangerous levels, investors try to mitigate risk and are expected to park their money in the least risky capital markets. That means those in the US and Japan.

The concept of carry trade will be disclosed later in this chapter, but a short definition would be: a strategy which involves buying or lending a currency with a high interest rate and selling or borrowing a currency with a low interest rate.

Japan is one of the world's largest exporters, which has resulted in a consistent trade surplus. A surplus occurs when a country's exports exceed its imports, therefore an inherent demand for Japanese Yen derives from that surplus situation. Japan is also a large importer and consumer of raw materials such as oil. Despite the Bank of Japan avoided raising interest rates to prevent capitalflows from increasing for a prolonged period, the Yen had a tendency to appreciate. This happened because of trade flows. Remember, a positive balance of trade indicates that capital is entering the economy at a more rapid rate than it is leaving, hence the value of the nation's currency should rise.

 

GBP (Pound Sterling)

This was the reference currency until the beginning of World War II, as most transactions took place in London. This is still the largest and most developed financial market in the world and as a result banking and finance have become strong contributors to the national economical growth. The United Kingdom is known to have one of the most effective central banks in the world, the Bank of England (BOE).

The Sterling is one of the four most liquid currencies in the Forex arena and one of the reasons is the mentioned highly developed capital market.

While 60% of the volume of foreign exchange are made via London, the Sterling is not the most traded currency. But the good reputation of the monetary policy of Great Britain and a high interest rate for a long time contributed to the popularity of this currency in the financial world.

Nickname: Cable or simply Sterling

Even though the economic unit using the Pound Sterling is technically the United Kingdom rather than Great Britain, the ISO currency code is GBP and not UKP as sometimes abbreviated. The full official name of the currency "Pound Sterling", is used mainly in formal contexts and also when it is necessary to distinguish the United Kingdom currency from other currencies with the same name such as the Guernsey Pound, Jersey Pound or Isle of Man Pound.
The currency name is sometimes abbreviated to just Sterling, particularly in the wholesale financial markets, while the term British Pound is commonly used in less formal contexts, although it is not an official name for the currency.

 

CHF (Swiss franc)

 Several factors such as a lengthy history of political neutrality and a financial system known for protecting the confidentiality of its investors, have created a save heaven reputation for Switzerland and its currency. Being the worlds largest destination of offshore capital.

The Swiss franc moves primarily on external events rather then domestic economic conditions, and is therefore sensitive to capital flows as risk-averse investors pile into Franc-denominated assets, during global risk aversion times. Also much of the debt from Eastern European economies is denominated in Swiss Francs.

Nickname: Swissy

 

CAD (Canadian Dollar)

Canada is commonly known as a resource based economy being a large producer and supplier of oil. The leading export market for Canada is by far the United States making its currency particularly sensitive to US consumption data and economical health.

Being a highly commodity dependent economy, the CAD is very correlated to oil - meaning that when oil trends higher, USD/CAD tends to trend lower and vice versa.

Nickname: Loonie

The nickname "Loonie" is derived from the picture of a loon, a distinctive bird which appears on one side of the Canada's gold-colored, one Dollar coin.

If Canada is one of the world's largest producers of oil and is such a big part of the US economy, rising oil prices tend to have a negative effect on the USD and a positive effect on the CAD. Here you have two nice correlations.
But if you are willing to find a pair which is really sensitive to oil prices, then pick the CAD/JPY. Canada and Japan are at the extreme ends of production and consumption of oil. While Canada benefits from higher oil prices, Japan's economy can suffer because it imports nearly all of the oil it consumes. This is another interesting correlation to follow. A brent crude oil spot chart is available at our World Indexes section.

 

AUD (Australian Dollar)

Australia is a big exporter to China and its economy and currency reflect any change in the situation in that country. The prevailing view is that the Australian Dollar offers diversification benefits in a portfolio containing the major world currencies because of its greater exposure to Asian economies. This correlation with the Shanghai stock exchange is to be added to the correlation it has with gold. The pair AUD/USD often rises and falls along with the price of gold. In the financial world, gold is viewed as a safe havenagainst inflation and it is one of the most traded commodities. Together with the New Zealand Dollar, the AUD is called a commodity currency. Australia's dependency on commodity (mineral and farm) exports has seen the Australian Dollar rally during global expansion periods and fall when mineral prices slumped, as commodities now account for most of its total exports.

The interest rates set by the Reserve Bank of Australia (RBA) have been the highest among industrialized countries and the relatively high liquidity of the AUD has made it an attractive tool for carry traders looking for a currency with the highest yields. These factors made the AUD very popular among currency traders. It's the 6th most traded currency in the world accounting for an estimated 6.8% of worldwide FX transactions in 2007, far in excess of the economy's importance (2% of global economic activity).

The AUD is under a free floating regime since 1983. Before that it was pegged to a group of currencies called the trade weighted index (TWI).

Nickname: Aussie

 

NZD (New Zealand Dollar)

This currency behaves similar to the AUD because New Zealand's economy is also trade oriented with much of its exports made up of commodities. The NZD also moves in tandem with commodity prices.

As per estimates from the last BIS triennal survey, in 2007 the NZD accounted for a daily transaction share volumeof 1,9% of total Forex transactions, after the Norwegian Krone, the Hong Kong Dollar and the Swedish Krone.

Along with the Australian Dollar, the NZD has been for many years a traditional vehicle for carry traders, which has made this currency also very sensitive to changes in interest rates. In 2007 the NZD was mainly used to conduct carry trades against the Japanese Yen accounting for a higher volume than the Australian Dollar against the Yen.

Nickname: Kiwi

 

Although there are many currencies worldwide, the vast majority of all daily transactions involve the exchange of the so called "major" currency pairs:

US Dollar / Japanese Yen (USD / JPY)

Euro / US Dollar (EUR / USD)

Pound Sterling / US Dollar (GBP / USD)

US Dollar / Swiss Franc (USD / CHF)

US Dollar / Canadian Dollar (USD / CAD)

Australian Dollar / US Dollar (AUD / USD)

The pair is always expressed with the convention: Base currency / Quote currency set by the Society for Worldwide Interbank Financial Telecommunication cooperative (SWIFT).

 

Other pairs where the US Dollar is not a member currency are called "crosses". Basically, a cross is any currency pair in which the US Dollar is neither the base nor the counter currency. For example, GBPJPY, EURJPY, EURCAD, and AUDNZD are all considered currency crosses.

When you think about buying or selling a cross currency pair, don't forget that the US Dollar, despite not being a member within the pair, is still influencing the price behavior of the cross. Buying EUR/JPY is equivalent to buying the EUR/USD currency pair and simultaneously buying the USD/JPY. Knowing from the previous chapter how interbank platforms work, you also understand why cross currency pairs frequently carry a higher transaction cost. To build a cross, interbank dealers have to combine two orders on different platforms.

The figure below shows the process of creating a cross currency pair.

 

By knowing how currencies are related and transacted you will be given a basic understanding on how to analyze trading opportunities on majors as well as on crosses. The principles guiding you to profit from a trade with a cross should be technically the same as with the majors: basically you want to analyze which is the strong and which is the weak currency within the pair.

By the same token, as crosses are created at the interbank level, you can create your crosses if they are not available with your preferred broker-dealer's platform. We call that creating "synthetic" pairs.

Let's assume a trader believes, based on a previous analysis, that there is an opportunity to profit from a weak Swedish Krone (SEK) and a strong Norwegian Krone (NOK), but the broker-dealer which the trader is using doesn't enable to sell the pair SEK/NOK. In this case all it takes is the trader to buy USD/SEK and to sell USD/NOK with equal position sizes. The position size depends on the pip value of the pair you are trading, as you will see later in this chapter.

Too many new concepts to put down a profitable trade? Don't worry, we will get there in a moment.

The figure below illustrates the process of synthetic pairing.