Definition of FOREX Currency Trading Pairs

When you think about a currency and its value, by what yardstick do you measure it: gold, silver or another commodity? The answer more often than not is another currency. When analysts talk about the value of a currency, they are referring to the relative value of the currency, the value of one currency with respect to another currency. This is a foreign exchange, or FOREX, currency trading pair.

1. Relative Value

   • In the modern world of fiat currency, that is currency that is created by decree and not backed by some physical commodity, currencies are very closely related. They all gain and lose value relative to each other, but they do not have intrinsic value. A currency cannot appreciate in a vacuum; if you hear that the dollar is stronger, it demands the question: stronger than what?

   Cash Foreign Exchange Market

   • Most of the major international currencies are traded against one another on some market. There are two primary types of foreign exchange transactions: cash and futures. The cash market is, as the name implies, the marketplace where large blocks of one currency are exchanged for another. The cash market does not occur at a given exchange, instead it is said to be over-the-counter, or OTC. These are markets "hosted" by large international banks and other institutions without the typical regulation of a securities or futures market.

   Futures Foreign Exchange Market

   • The futures market, however, does occur in regulated marketplaces, including The Intercontinental Exchange and The Chicago Mercantile Exchange. On both the futures and the OTC cash markets, the transactions are standardized. For example, if you were interested in trading the CME futures contract for the Euro against the US dollar, then you would be transacting a notional 125,000 Euros. The contract would be priced in USD per Euro, so the exchange rate for dollars to Euros would be quoted $1.3752 per one Euro.

   Currency Pair Pricing

   • By definition, any currency pair could be expressed in either currency, but the convention, at least in the United States, is to quote currencies in USD per other currency. One notable exception is the Japanese Yen, which is usually quoted in Yen per USD. Another possibility is a currency "cross." This would be a pair that does not involve the USD. One commonly referenced cross traded on the CME is the British Pound and the Swiss Franc, symbol GBP/CHF.

   Foreign Exchange vs. Currency Exchange

   • The foreign exchange markets inform, but remain distinct from, actual physically exchanged currency. If you exchange a lot of currency, you've probably noticed that the exchange rate at a point of physical exchange is never quite as good as the market might quote. This is because exchange and OTC traded foreign exchange rarely resort to actual exchange of blocks of currency. Instead the profits and losses for trading are debited or credited electronically. Currency exchange demands a premium rate in order to pay for the cost of having real money on hand.