The foreign exchange market is centred around the practice of buying quantities of different global currencies with a view to making a profit through the disparity in relative value between them.
This is why currencies are always traded in pairs, whereby the value of the first (the ‘base’ currency) is quoted against another (the ‘counter’ currency); for example, when examining the current rate for GBP/USD, you’re basically looking at how many US dollars you could buy with every unit of the British pound you currently possess.
Hundreds of currencies are traded across the foreign exchange market in a complex array of combinations; however, research suggests that around 85% of all forex activity is conducted using just seven distinct currency pairs. These are known collectively as the ‘majors’, and all involve the USD dollar — the primary global reserve currency and the most widely used currency internationally — as one half of the pair.
Here’s a quick overview of the four major pairs that aspiring traders will most want to familiarise themselves with:
EUR/USD (‘Euro’)
The US and EU are the world’s two pre-eminent economic forces, so it’s no surprise that the US dollar and Euro — the latter of which is used throughout the European and Economic Monetary Union, or ‘eurozone’ — are the two most frequently traded currencies worldwide, with EUR/USD being the most commonly traded currency pair.
The direction of this pair is mostly dictated by the strengths of the respective US and European economies, as well as key releases by the US Federal Reserve and European Central Bank (ECB).
However, the Euro has also traditionally been vulnerable to drops arising from financial disagreements between the 28 EU member states — and, more recently, political turbulence and speculation regarding the UK’s planned withdrawal from the EU (colloquially termed ‘Brexit’).
GBP/USD (‘Cable’)
The pairing between the British pound and US dollar is colloquially known as the ‘cable’, which refers back to the 1800s — the pre-internet, pre-satellite era — when the London and New York Stock Exchanges communicated via a steel subsea cable that ran the length of the Atlantic Ocean.
Despite its comparatively small landmass, International Monetary Fund (IMF) statistics have indicated that the UK has the fifth largest GDP of any country worldwide. Its economy is also closely linked to that of the neighbouring EU, which is why the GBP/USD pair has many behavioural similarities with the Euro.
Historically speaking, it’s also significant that the GBP acted as the global reserve currency before being displaced by the USD following World War II — and London’s reputation as a major financial centre keeps the cable among the most important (and most liquid) pairs in modern times.
USD/JPY (‘Yen’)
Also nicknamed the ‘Ninja’ or ‘Gopher’, the US dollar and Japanese yen is the second-most frequently traded pair worldwide, having gained prominence as a result of the yen’s ‘safe-haven currency’ status — meaning it is often bought by investors in turbulent economic climates as a reliable store of value.
Indeed, forex traders fall back on the JPY so frequently that it was once tipped to become the world’s main reserve currency during a period of particularly strong performance during the 1980s; however, the country’s later economic struggles meant this never quite materialised.
Nevertheless, the Japanese yen remains the most liquid currency in Asia, as even though China has a bigger economy the country’s more restrictive fiscal policies mean the yuan isn’t traded on the open market with the same frequency.
Speculators commonly trade the ninja at very high volumes due to the low bid-ask spreads involved, and carry trader often borrow the JPY to subsequently invest into higher yielding currencies due to characteristically low interest rates! This is partly a consequence of Japan being one of the biggest exporting countries globally; around 40% of the total Japanese GDP is thought to come from exports — as such, the Bank of Japan often intervenes in the economy, and low interest rates are part of its ongoing efforts to combat low inflation and stimulate growth.
USD/CHF (‘Swissie’)
Perhaps surprisingly, the US dollar-Swiss franc combination represents the fifth most frequently traded pair worldwide, with its popularity in part due to the latter’s long-standing zero inflation policy and reputation as a safe-haven currency in times of upheaval.
In fact, the nation of Switzerland has become known globally for discretion, neutrality and economic stability in general — it’s no coincidence that the country hasn’t been involved in a single armed conflict since the Treaty of Paris was signed way back in 1815!
The Swiss Confederation is also notable for being a close trading partner with its European neighbours without formally being part of the eurozone (or adopting the Euro as a currency) itself. As a result, the Swissie pair has always displayed a near-perfect negative correlation with EUR/USD, meaning that one rises as the other falls and vice versa — it also has a similar negative correlation with gold.
In addition to the ‘big four’, there are also three further pairs that are often thought to be similarly prominent on the forex market as ‘commodity currencies’, which reflect the strength of their respective exporting industries:
USD/CAD (‘Loonie’)
One of the most popular commodity pairs, the USD/CAD gets its nickname from the Canadian dollar coin, which features an image of a loon bird on the reverse side.
The Canadian dollar is closely linked to the US dollar, having previously come under the remit of the gold standard between 1854 and 1914; this arrangement fixed it in relation to the value of gold and put the two currencies on a par, beginning a long-standing relationship.
Both countries also share a vast land border and trade huge volumes of goods with each other, and the exchange rate between the two is affected heavily by the interest rate differential between the Bank of Canada and US Federal Reserve.
Despite this close geographical and historical link, recent trade tariff wars between US President Donald Trump and Canadian Prime Minister Justin Trudeau have made the loonie more vulnerable to market volatility than in previous years.
Additionally, thanks to its vast natural reserves of timber, natural gas and crude oil, Canada’s economy is hugely dependent on commodity prices; the country increased its oil exporting rate every year during the last decade, exporting an estimated 3.5 million barrels of oil per day to the US alone in 2018.
AUD/USD (‘Aussie’)
Both the US dollar and Australian dollar play a key role in global economic affairs; the latter replaced the pre-decimal Australian pound in 1966, which was pegged to the value of the British pound sterling.
Australia has an active mining industry and the AUD is largely tied to the success of its mining commodities — the country being a major exporter of precious metals coal and iron ore — as well as rural farming-based products such as wheat, wool and beef.
The Aussie is also heavily affected by decisions made by the Reserve Bank of Australia (RBA) — which meets on the first Tuesday of every month except January, with key meeting notes generally made public two weeks later — and the US Federal Reserve.
Interestingly, the AUD tends to fare better when China’s economy is prospering due to the large amounts of trade occurring each year between Australia and China; Australia is one of the few nations worldwide to run a trading surplus with the Asian nation, with around a third of Aussie exports being sent to China annually.
Furthermore — owing to the fact that most commodities are denominated in USD — the Aussie pair can also be considered a reliable price barometer for the global commodities market as a whole. Conversely, the pair tends to display a negative correlation with the USD/JPY and USD/CHF trends.
NZD/USD (‘Kiwi’)
Affectionately nicknamed after the flightless bird famously endemic to New Zealand that’s pictured on its $1 coin, the New Zealand dollar was introduced as the country’s official currency in 1967 to replace the British pound. Originally pegged to its historical predecessor, GBP, the NZD is now considered a free-flowing currency, mainly affected by New Zealand’s agriculture and tourism data releases.
As country rich in natural resources, it is also a top-five exporter of milk and other dairy produce — recent research showed milk powder, butter and cheese accounted for over 20% of the country’s total exports — meaning the Kiwi often appreciates against the US dollar in tandem with the price of milk products.
The NZD/USD pair is considered particularly sensitive to changes in monetary policy from either Reserve Bank of New Zealand or the US Fed, and can also prove volatile around key national events such as the New Zealand Dairy Auction.
It’s also worth noting that the Royal Bank of New Zealand takes a hands-on approach to managing inflation within the region, and the country’s high interest rates– set at 2% in 2016 compared to just 0.5% for the USD during the same period — have made NZD to USD a popular strategic purchase for carry traders.