Those who are new to Forex trading may be unaware of a great deal of Foreign exchange terminology. The goal of this post is to introduce the reader to what are often considered the four major currency pairings. You will often hear of currency pairings being referred to majors and minors, with major currency pairings being the most popular pairings to trade.
In Forex trading the four major currency pairings are as follows:
- EUR/USD: The Euro against the US Dollar
- USD/JPY: The US Dollar against the Japanese Yen
- GBP/USD: The Great British pound against the US Dollar
- USD/CHF: The US Dollar against the Swiss Franc (the CHF symbol often catches people of guard)
In this first post of the series we are going to focus on the EUR/USD, to be followed by the USD/JPY, GBP/USD before finishing off with the USD/CHF.
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The United States of America and Eurozone are two of the worlds largest economic entities. Combined these two entities represent around 48-50% of global GDP (correct 2013). The US Dollar also happens to be the world most traded and held currency, with many countries relying on the US Dollar as it primary currency or alternatively using the US Dollar as a reserve currency. The currency of the 17 members of the Eurozone, is the world second most popular currency due to the economic strength of a number of Western European countries. Because of the importance of these two currencies, it is unsurprising that the EUR/USD is the worlds most actively traded currency pairing.
The US Economy in Focus
The United States of America is the worlds largest national economy, but some suggest it is only a matter of time before China overtakes America to become top dog. The US economy has an impressive gross domestic product of nearly $15 trillion dollars (2011 figures). While the US economy is largely serviced based, but manufacturing still contributes around 12% of US GDP (2012 figure). When the US economy is strong, the dollar generally strengthens and conversely when the economy goes through a rough patch, the dollar usually weakens. The US is generally considered a financial safe haven and in times of turmoil people often turn to the US Dollar, often causing the Dollar to strengthen. Economic policy in America has generally favored a strong Dollar and policy makers have tended to intervene if they have perceived the Dollar to be too weak.
How the US Dollar plays a unique role
It should be stressed that the US currency plays somewhat of a unique role. Having the honor of being the world’s primary reserve currency. The historic strength and safe haven status of the US Dollar has led to foreign governments to keep a significant percentage of their foreign currency reserves in the US Dollar. In addition to this many smaller countries who do not operate floating exchange rates choose to peg their currency against the US Dollar. It should be noted that a number of smaller countries use the US Dollar as a primary currency either officially or unofficially.
The US Dollar also plays a unique role in global trade, with the price of Gold and other commonly traded commodities being set in Dollars. Not only this OPEC (The Organization of Petroleum Exporting Countries) undertakes all of it’s transactions in the US Dollar, meaning that when a nation buys or sells Oil from OPEC it is buying or selling US Dollars at the very same time. This central role in global trade also plays role in cementing the US Dollar’s status as the most traded global currency.
All of this means that it is important for those who wish to trade the currency markets have a strong grasp of the fundamentals that drive the US economy.
The Economy of the Eurozone
The European Union is the worlds largest economic region with a GDP in excess of $16 trillion dollars. However, the GDP of the Eurozone is significantly smaller as only 17 of the 27 EU member states are part of the Eurozone. In 2012, it was reported that the combined GDP of Eurozone countries amounted to around $12.2 trillion dollars. Similarly, to the United States the Eurozone economy is dominated by service provision though manufacturing still makes up a greater percentage of Eurozone GDP than it does in the US. When the Eurozone is enjoying strong economic growth the value of the Euro tends to strengthen and when times aren’t as great the price tends to weaken.
How the Eurozone is unique
While the US Dollar is the currency of a single country (though a number of countries have adopted it as their own), the Euro is the single shared currency of 17 European Union states. The group of EU countries which are part of the Euro are often referred to as the Eurozone countries, though the group is more formally known as the European Economic and Monetary Union. The fact that the Euro is a shared currency often leads to particular disputes among member countries regarding the future course of the European Union and what kind of monetary policy should be pursued.
The current 17 members of the Eurozone are as follows:
Factors Influencing the EUR/USD
The primary factor that influences the price of the EUR/USD pairing and all other Forex pairings is the relative strength of the two economies. With all other factors being equal a US economy which is growing faster than the Eurozone, will result in the US Dollar strengthening in value. Conversely if growth in the Eurozone is outstripping growth in the US, it is likely that the Euro will strengthen against the Dollar. However, the relative strength of the two economies is not the only factor at play. A number of other factors are important to the price of the EUR/USD including:
- The level of interest rates in the two countries.
- Political instability in the Eurozone or US.
- Troublesome Economic information regarding a Eurozone country.
Trading the EUR/USD
- Low spreads
- High Volatility, plenty of opportunity to for profitable short term trades.
- Ease of access to both economic and financial data.
- Plenty of price sensitive news releases.
- The popularity of the currency pairing means arbitrage opportunities happen rarely if ever.
For those looking to get into Forex trading the high liquidity and volatility of the EUR/USD makes its an excellent pairing to get to grips with. Those who are looking to trade the pairing should look to learn about the various economic and political factors that influence the price of the pairing. Of course, as with all trading there are significant risks and those who wish to trade the EUR/USD should make sure they do not trade beyond their limits as well implementing proper risk management.
Part 2:USD/JPY (Coming Soon)