When you look at a forex currency pair, you can see how two currencies are related. The base currency and the quotation currency describe this connection. The first currency in the pair is the base currency, and it’s the one you’re buying or selling. The second currency is the quote currency, and its value tells you how much of it you need to get one unit of the base currency.
Getting to Know the Roles
A currency pair is like a price tag. The Euro (EUR) is the base currency in the pair EUR/USD, and the U.S. dollar (USD) is the quoted currency. If the price is 1.1000, then one Euro is worth $1.10. It is usually assumed that the base currency is worth one. The amount on the screen shows how much the quote currency is worth in terms of one base currency unit.
This is the main idea that all other parts of forex trading are based on. If the exchange rate for EUR/USD goes up from 1.1000 to 1.1050, it signifies that the Euro is worth more than the U.S. dollar. It costs more dollars to buy one Euro now. On the other hand, the Euro has been weaker if the rate goes down.
The Process of Buying and Selling
Knowing the base and quotation currencies is very important since it tells you exactly what you’re doing in a deal.
When you buy a currency pair, you are selling the quote currency and buying the base currency at the same time. If you buy EUR/USD, for example, you are trading your U.S. dollars for Euros. You think the Euro will be worth more than the U.S. dollar, which is why you’re doing this.
When you sell a currency pair, you are selling the base currency and buying the quote currency at the same time. When you sell EUR/USD, you are trading your Euros for U.S. dollars and hoping that the value of the Euro will go down.
This is true for every deal. When you trade USD/JPY and buy, you’re selling Japanese yen and buying U.S. dollars. When you sell it, you are buying Japanese yen and selling U.S. dollars. Your actions are based on the base currency, and the quote currency is how you pay or what you get when you sell.
Why Convention Matters
You may note that the U.S. dollar is sometimes the base currency and sometimes the quote currency. Market convention determines the ranking of major currency pairs. The U.S. dollar is the currency for EUR/USD, GBP/USD, and AUD/USD, for example. People call this “American terms.”
When the U.S. dollar is coupled with the Japanese yen, Swiss franc, or Canadian dollar, though, it is usually the base currency (USD/JPY, USD/CHF, USD/CAD). This is known as “European terms,” but it doesn’t only apply to European currencies. This standardization makes it easy for everyone in the market to grasp a quote right away.
The most traded pairs are the major ones, which include the U.S. dollar. They are great for traders of all skill levels since they have strong liquidity and narrow spreads. Pairings that don’t have the USD in them are called “crosses” or “minor pairs” (like EUR/JPY). “Exotic pairs” (such as USD/TRY) consist of a major currency and a currency from an emerging economy.
The Bottom Line
A forex pair has two main parts: the base currency and the quote currency. The base currency is the one you are valuing (always one unit), and the quote currency is the one you are using to value it. The base currency gets stronger when the rate goes up. The base currency is getting weaker when it goes down. The first and most critical step to being able to trade in the foreign currency market with confidence is to understand this simple principle.
Questions and Answers
Q: Is it possible for a currency to be both a base and a quotation currency?
A: Yes. The U.S. dollar is a fantastic example. In pairs like EUR/USD, it’s the quote currency, whereas in pairs like USD/JPY, it’s the base currency. It all relies on the pair and the market rules.
Q: Does the order of the currencies affect the value?
A: Yes, of course. The sequence is the most important factor. The EUR/USD pair is not the same as the USD/EUR pair. One euro is worth 1.10 USD while the EUR/USD exchange rate is at 1.1000. The opposite, USD/EUR, would be about 0.9090, which means that 1 USD is equal to 0.9090 Euros.
Q: Why is this so important to traders?A: It’s what every calculation is based on. The amount of money you made and lost is calculated using the quote currency. If your trading account is in U.S. dollars and you trade EUR/USD, for instance, your earnings and losses will show up right away in U.S. dollars, which makes things easier.
