Currencies are always exchanged in pairs. For instance, EUR/USD signifies Euro against US dollars, which is a common pairing. Here, the Euro, listed first, acts as the base currency. The second currency, which is USD by default, is known as the counter or quote currency. Since the Euro is the base currency, the amount of it in the pair indicates how much is needed to acquire one unit of the second currency. Therefore, when you decide to purchase the currency pair, you’re essentially buying the Euro and simultaneously selling the USD. Conversely, if you intend to sell the currency pair, you would sell the Euro while buying USD. It’s crucial to grasp that in a currency pair or a Forex transaction, you are engaging in buying or selling the same currency.
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US DOLLAR The United States dollar stands as the primary currency globally – a standard to assess all other currencies traded on Forex. Typically, all currencies are expressed in terms of the US dollar. During times of international economic or political instability, the US dollar serves as the principal safe-haven currency, as evidenced during the Southeast Asian crisis of 1997-1998. Historically, the US dollar emerged as the dominant currency towards the end of World War II as a result of the Bretton Woods Accord, with other currencies effectively pegged to it. The arrival of the Euro in 1999 slightly diminished the dollar’s significance, though not substantially. Other key currencies traded against the US dollar include the Euro, Japanese Yen, British Pound, and Swiss Franc.
EURO The Euro was created to be the leading currency in trading, presented primarily in American terms. Like the US dollar, the Euro enjoys substantial international presence due to the members of the European Monetary Union. However, it struggles with uneven growth, high unemployment, and governmental reluctance to implement structural reforms. The Euro faced additional challenges in 1999 and 2000 from foreign investor withdrawals, especially from Japanese investors liquidating losing euro-denominated assets. Additionally, European money managers adjusted their portfolios, minimizing Euro exposure as their need to hedge against currency risk in Europe lessened.
JAPANESE YEN As the third most traded currency worldwide, the Japanese Yen lacks the global presence of the US dollar or the Euro. It enjoys high liquidity almost all day long. The demand for the Yen is largely driven by Japanese keiretsu, which are economic and financial conglomerates. Its value is closely linked to the performance of the Nikkei index, Japan’s stock market, as well as the nation’s real estate sector.
BRITISH POUND Before the conclusion of World War II, the Pound was the reference currency. It is heavily traded against both the Euro and the US dollar, but it has a more inconsistent presence when compared with other currencies. Before the Euro was introduced, the Pound thrived amid uncertainties regarding currency convergence. Once the Euro launched, the Bank of England aimed to align UK interest rates with the lower rates found in the Eurozone. There was a possibility for the Pound to adopt the Euro in the early 2000s, depending on a favorable result from the UK referendum.
SWISS FRANC The Swiss Franc stands out as the only major European currency that is not a member of either the European Monetary Union or the G-7 nations. Despite Switzerland’s relatively small economy, the Swiss Franc ranks among the top four major currencies due to its connection to the robust nature of Swiss economy and finance. Switzerland maintains a strong economic relationship with Germany, contributing to its ties with the Eurozone. In light of political instability in the East, many investors tend to prefer the Swiss Franc over the Euro. Traditionally, the Swiss Franc is considered a stable currency, and while it often mirrors the Euro’s patterns in foreign exchange, it does not share the same level of liquidity. The increasing demand for the Franc can lead to greater volatility compared to the Euro. The Canadian Dollar and the Australian Dollar are also traded in the Forex market, but they aren’t classified as major currencies due to lower trading volumes and circulation, and they primarily trade against the US Dollar. Added: The Forex market was formed in 1971 when floating exchange rates started to appear. Unlike currency futures or stock markets, the Forex market operates without a central hub. Trading is conducted via computers and phones from countless locations around the globe. Known as FOREX, this market allows banks, investors, and speculators to trade currencies with one another. The bulk of foreign exchange activity is dominated by spot exchanges involving five key currencies: the US Dollar, British Pound, Japanese Yen, Eurodollar, and Swiss Franc. Moreover, it’s the largest financial market on the planet. For perspective, while the US stock market might handle about $10 billion in a day, the Forex market can reach up to $2 trillion in transactions daily. This market operates 24 hours a day, primarily through the continuous Interbank market. It follows the sun’s path, shifting from the major banking hubs in the United States to Australia and New Zealand, then to Asia and Europe, eventually circling back to the US. Until now, seasoned traders from prominent international commercial and investment banks have largely influenced the FX market. Other participants include large multinational firms, global fund managers, registered dealers, international money brokers, futures and options traders, and private speculators. There are three primary motivations for engaging in the FX market. One is to facilitate real transactions, allowing international corporations to convert foreign currency profits into their home currency. Corporate treasurers and asset managers also participate in the FX market to protect against unwanted future currency price fluctuations. The third and more common reason is to speculate for profit. In fact, it is estimated that currently, less than 5% of Forex trading is linked to actual commercial transactions. The FX market is classified as an Over The Counter (OTC) or ‘Interbank’ market because trades occur directly between two parties, either over the phone or through an electronic network. Unlike stock and futures markets, trading isn’t centralized on an exchange. Forex trading operates around the clock, starting daily in Sydney and then progressing globally to Tokyo, London, and New York. Unlike any other financial market, investors can react to currency changes driven by economic, social, and political events as they happen—day or night.
CANADIAN DOLLAR Canada opted for the dollar over a Pound Sterling system primarily because of the widespread use of Spanish dollars in North America during the 18th and early 19th centuries, alongside the standardization brought about by the American dollar. Starting January 1, 1858, the Province of Canada mandated that all accounts be maintained in dollars and issued the first official Canadian dollars that same year. Over the following years, the colonies that united to form Canada gradually adopted a decimal currency system.
AUSTRALIAN DOLLAR Introduced on February 14, 1966, the Australian Dollar replaced the Australian Pound and implemented a decimal system. After the Australian Dollar’s introduction, its value continued to be managed according to the Bretton Woods gold standard, which had been in effect since 1954. This meant that the Australian Dollar’s value was aligned with gold, although, in practice, it was tied to the US dollar. In 1983, the Australian government decided to “float” the dollar, allowing it to operate independently from the US dollar and other foreign currencies. Currently, the value of the Australian Dollar is primarily influenced by domestic measurements, such as the Consumer Price Index (CPI).