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Forex 101: How currency pairs work

by , 05 November 2015

If you decide to trade forex, one of the first things you'll come across is that currencies come in pairs.

You can't trade a currency in isolation, you always trade it with another currency.

So how do currency pairs work? And what does a currency pair tell you?

Read on to find out more…


An introduction to currency pairs

 
The value of one currency is always relative to the value of another currency, this is why there are currency pairs. You can determine the value of one currency by comparing it to the value of another currency.
 
When you trade forex, this means you buy one currency and sell another currency at the same time. 
 
For example, you buy rands with US dollars as you think the value of the rands will rise in value against the US dollar. If the rand rises (strengthens) against the dollar, you can sell it and make a profit. This is because you’ll receive more US dollars back than what you initially paid for the rands.
 
Each currency is shortened to a three letter abbreviation. For example:
 
  • For the rand, it’s ZAR;
  • For the US dollar, it’s USD; and
  • For the euro, it’s EUR.
 

The different quotes of currency pairs

 
The first currency in a currency quote is the base or primary currency. So if you have the currency quote USD/ZAR, the USD (US dollar) is equal to $1. 
 
Say the USD/ZAR currency quote is 14.0000. This means you need R14 to buy $1.
 
The second currency in a currency quote is the quote currency or secondary currency. So in our example, the quote currency is rands (ZAR).
 
There are two ways to quote a currency.
 
The first is a direct quotation. For our example, this is USD/ZAR 14.0000. In other words, you need R14 to buy $1.
 
The second is an indirect quotation. For our example, this is ZAR/USD 0.0714. In other words, you need $0.07 to buy R1.
 
So there you have it. How currency pairs work.
 
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Forex 101: How currency pairs work
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