All transactions in the Forex market involve currency pairs. A currency pair consists of two currencies that are traded against each other, and the value of these pairs represents the current Forex rates. Forex currency pairs compare two currencies, where the value of the first currency, known as the base currency, is quoted against the second currency, known as the quote currency.
If you’re familiar with exchanging money while traveling, think of your local currency as the base currency and the foreign currency as the quote currency. In the Forex market, each currency uses a unique three-letter code assigned by the International Organization for Standardization (ISO), known as the ISO currency code. For example, the U.S. dollar has the ISO code USD, while the British pound sterling is listed as GBP.
Decoding Forex Currency Pairs
When trading in the Forex market, your trading position is determined by the exchange rate of both currencies in a currency pair. For instance, consider the GBP/USD currency pair. When trading this pair, there are two different values – GBP/USD and USD/GBP.
In the GBP/USD pair, GBP is the base currency, and USD is the quote currency. Each pair has a direct exchange rate and an indirect exchange rate.
Direct Exchange Rate: Direct exchange rates are those where the price of one unit of the base currency is given in terms of the quote currency.
For example, if the GBP/USD pair has a direct exchange rate of 1 GBP = 1.11 USD, it means that one British pound can buy 1.11 U.S. dollars.
Indirect Exchange Rate: Indirect exchange rates are those where the price of one unit of the quote currency is given in terms of the base currency.
Using the same example, if the GBP/USD pair has an indirect exchange rate of 1 USD = 0.90 GBP, it means that one U.S. dollar can buy 0.90 British pounds.
Referring back to the example of exchanging local and foreign currency, a direct exchange occurs when you exchange your local currency for foreign currency, while an indirect exchange occurs when you exchange foreign currency for your local currency.
How Do You Choose Your Currency Pair?
In Forex trading, it is assumed that you buy a currency pair expecting the base currency to increase in value and sell a currency pair expecting the base currency to decrease in value. If you buy the GBP/USD pair, you are essentially predicting that the value of one pound will be higher than its current value while the value of the U.S. dollar remains the same or decreases. Similarly, if you trade this pair by selling, it means you predict the value of the pound will decrease against the U.S. dollar and you want to sell it before the price drops further.
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