Currency Pairs: Exchange Rates - Types of Currency Pairs (Module 3)
In the forex market, traders mainly do currency pairs purchase. However, it's not just about choosing a pair, because there are moments where one is better than the other. In this module, we are to learn about the different types of currency pairs and which is best to purchase at a specific moment.
Three Types od Currency Pairs
TMajor pairs are the most often traded currencies around the globe. They have bigger liquidity and traded virtually on a regular basis. These pairs have the lowest spreads, meaning low brokerage costs.
As you can see in major pairs, the United States Dollar is always included. That mainly because the U.S. dollar is the leading reserve currency around the globe. It involves in around 88 percent of the whole currency trades.
Minor pairs in some way in contrasts of the major pairs for it does not involve any U.S. dollar. The minor pairs are also known as the cross currency pairs. These pairs represent a wilder swing because of its lesser liquidity.
The minor pairs are mostly active on cross-trading within three major non-USD currencies. That currencies are EUR, JPY, and GBP.
The exotic pairs are the pairs that are rarely traded within the mainstream markets. Exotic pairs are consist of major currency pairs with the emerging economy's currency. This economy can be strong yet smaller in a global perspective. For instance, Singapore, Hong Kong, and those European countries outside the Eurozone.
The exotic pairs aren't traded as frequently as the minors and major pairs. Which means the cost of trading within these pairs can go higher than the other pairs because of its little or lack of liquidity.
Now, choosing the pair that you are to trade isn't just about choosing which have narrow spread with high liquidity. Most rookies made that same mistake in trade. If you are not sure how to do multiple pair trading at the same time, you might slowly see your account burn. Continue ready now to avoid that same mistake.
The Currency Correlation
In trading forex, you need to understand that any currency doesn't work on its own in the forex market. Currencies are always quoted in pairs. Meaning, all currencies are somehow connected or interlinked.
Now, the term currency correlation refers to whether two pairs moves the same, opposite or in a random direction. That said, it is necessary to understand the different movements of each pair in relation to each other. Moreover, if you don't familiarize yourself with how currency correlations works it could affect the same amount of risk you expose.
How would you then know if it's a correlation? If you notice a currency pair rises and another falls, that is a correlation. Even if the pair falls, and the other pair falls at the same time, it is a correlation.
The Correlation Coefficient
The Correlation coefficient ranges between -1 and +1, that’s how most traders measure the correlation. If you reach +1, that's a perfect positive correlation. Meaning, two currency pairs are to move within the same direction 100 percent of the time..
But if you reach -1, that is a perfect negative correlation. Meaning, two currency pairs are to move in the opposite direction 100 percent of the time.
Now, what if the correlation is 0?
The 0 correlations are completely independent and are to move randomly against each other. The currency pairs included are the AUD/USD, EUR/USD, GBP/USD, and USD. All are positively correlated against each other.
Hence, the changes in the strength of the U.S. dollar instantly affects the pair as a whole. The USD/CHF, USD/CAD, and USD/JPY are negatively correlated pairs. If you've observed, the base currency is the US dollar. The reason is that they move in the opposite direction of the majors mentioned before.
What are the factors that make the pairs move?
Currency pairs don't randomly move up or down. There are several factors that make the market move. Below are some of the main factors.
The non-farm payrolls are about the date referring to the number of people employed within an economy. If employment notably declines, it means that the economy is contracting. But if the employment rate increases, that shows a strong economy.
- Interest Rates
Interest rates play a big role in the forex market. As central banks formulate monetary policy and supply, they are the main focus of traders. The increase in interest rates could cause a currency to appreciate as higher rates are provided to lenders. It will then attract more foreign capital, resulting in a rise in exchange rates.
As there are big amounts of goods and services available within the country, grouping the products are used in measuring changes in the pricing. The increase in pricing show an increase in inflation rate resulting in a possible devalue on the country's currency.
- Gross Domestic Product (GDP)
Now, this is how to look for the measurement of goods and services which were finished over a period of time. GDP is split into 4 categories (business pending, government spending, private consumption, and total net exports.
There are other factors to consider in which currency pairs move prices. Others included are retail sales, durable goods, trade and capital flows, macroeconomic & geopolitical, and daily news & market data.
That end our module 3 for "Easy Forex: Trading Guide For Beginners (series module)." Hope to have you in our next module.
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