Currency market trading is unique in that you are betting on the increase or decline of one currency by initiating a position. Two currencies are included in a same instrument, and the value of one is quoted in relation to the value of the other. A currency pair’s currencies are also referred to appropriately; that is, the base currency is the first currency and the quoted currency is the second. Therefore, the US dollar is the quoted currency in the most traded currency pair, while the euro is the base currency. Thus, the value of one euro expressed in a specific amount of US dollars is represented by the EURUSD pair.
How are currency pairs quoted?
Forex traders don’t give it much thought because they assume that currency pairs are traded in a specific style. However, why are individual currency pairs priced the way we are accustomed to seeing them on trading platforms? The solution is actually rather straightforward: traditions are to blame, and there isn’t, in theory, a definite rule that determines currency quotes in forex.
The International Organization for Standardization is responsible for defining the explicit definitions of the acronyms used for the currencies themselves.
Since the USD is the most traded currency on the forex market, it stands to reason that it would be the top currency in the majority of pairs. However, neither the strength nor the liquidity of a currency determines its position in a currency pair. In actuality, the USD typically has a higher value when it is listed as the base currency in combinations with less-traded or exotic currencies.
Clearly defined order
The following order is the fundamental guideline that establishes the mutual quotation of the ten most significant currencies, or the currencies of the G10 nations: The currencies are EUR, GBP, AUD, NZD, USD, CAD, CHF, NOK, SEK, and JPY.
Since the British pound is the oldest currency still in widespread use today, the order of the GBPUSD pair is based on both historical tradition and the currency’s strength. It was first linked to gold in 760 and remained so until 1940.
This is similar to the AUDUSD and NZDUSD pairs, for example, as both the Australian and New Zealand dollar have historically had a close link to the British pound. Here, the US dollar is the stronger currency, yet it is listed as the second most valuable currency (however, in the early days of forex in the 1970s, both AUD and NZD were more valuable than the dollar).
The Swiss franc has been the more valuable currency lately, and it is once again the weaker one in the USDCHF pair. Even so, this is more of a recent issue because the CHF is regarded as the most well-liked safe haven among traders, and as a result, its value has increased dramatically since the year 2000.
The EURGBP pair is an intriguing example, as it makes the euro the only currency that appears as the base currency (i.e., first position) in all currency pairs. This is one of the rare instances in which the traders themselves have determined how this pair will be traded in forex, despite the fact that the base currency has never been stronger than the quoted currency. London bank officials, accustomed to the previous convention that the GBP was always first, disagreed with the ECB’s 1998 decision to establish the euro, which stated that the euro would always be placed first in currency combinations.
Another interesting feature are some of the rules used by some financial institutions in their home market. In the case of the EURGBP pair, some UK institutions use the GBPEUR quote, the British pound being their natural base currency. The reverse is true for companies in Switzerland, who prefer to quote with CHF in second place and therefore their domestic banks provide them with the JPYCHF rate, even though the basic rule is to quote CHFJPY on the forex market.
Rates that are precise to the tenth of a penny
Until 2006, the exchange rates of individual currencies in the spot market on Forex were quoted to four decimal places, with the fourth decimal place representing one pip. Another unwritten rule was that rates that were worth more than 20 were quoted to three decimal places and rates that were worth more than 80 (for example, pairs with the Japanese yen) were quoted to two decimal places. However, in 2005, Barclays Capital introduced an innovation in its platform in which it added an additional decimal place for several of the most traded pairs. This allowed prices to be quoted in tenths of a pip and this more accurate pricing was then adopted by other banks and institutions, allowing the quotes from individual institutions to vary and creating a more competitive market. It is now quite common for most pairs to be quoted to five decimal places in the spot market and for pairs with the Japanese yen to be quoted to three decimal places.