The foreign exchange trading system, which goes by its formal name of Forex trading, enables people to trade different foreign exchange currencies. In trading history, the currency pair EUR/USD established itself as the most profitable. The Japanese Yen and Chinese Yuan currencies demonstrate substantial appreciation due to China holding the title of the world leader in forex reserve possessions.
This leads you to revise your decisions on choosing the right currency pair to trade. So, let's take a look at the key factors for selecting the most suitable currency pairs and be profitable from your journey in Forex trading.
This leads you to revise your decisions on choosing the right currency pair to trade. So, let's take a look at the key factors for selecting the most suitable currency pairs and be profitable from your journey in Forex trading.
Understanding Currency Pairs
The straight-cut meaning of a currency pair is basically the exchange rate between two separate currencies. In the arena of algo trading, traders trade constantly in currency pairs by simultaneously buying in one currency from the pair to sell in the other.
The two aspects that form a currency pair include the base unit and the quoted unit. The base currency is the initial currency to appear in a pair, while the quote currency follows it as second in the pair.
The quote currency, USD, comes after the base currency, EUR, in the EUR/USD currency pair. Trading currency pairs demonstrates the quantity of quote currency you need to obtain one unit of base currency.
The currency pair popularity leads to three distinct groups.
The two aspects that form a currency pair include the base unit and the quoted unit. The base currency is the initial currency to appear in a pair, while the quote currency follows it as second in the pair.
The quote currency, USD, comes after the base currency, EUR, in the EUR/USD currency pair. Trading currency pairs demonstrates the quantity of quote currency you need to obtain one unit of base currency.
The currency pair popularity leads to three distinct groups.
- Major Currency Pairs: The most popular currency pairs for forex trading include major currency pairs, which consist of EUR/USD and, USD/JPY, and several others.
- Minor Currency Pairs: The group contains pairs containing currencies from smaller economies and excludes USD involvement, like AUD/JPY.
- Exotic Currency Pairs: A currency pair receiving both major and emerging market currency membership is categorized as an exotic pair like USD/SGD.
Key Factors to Consider When Choosing a Currency Pair
Liquidity characteristics, market volatility, and operating patterns separate currency pairs. The EUR/USD Forex pair is the most traded Forex pair; thus, it maintains high levels of liquidity that decrease its market volatility compared to minor or exotic pairs. Understanding these differences becomes important in making the right choice for which one to trade.
1: Liquidity and Volatility
The liquidity of a currency confirms its quick and easily transactions. Highly liquid currencies remains always high on demand in the forex market due to their low transaction costs along with ease of transaction.
There are almost 180 currencies in the Forex market, but only the top 7 of them composes the most popular currency pairs due to their high liquidity. Highly liquid currency pairs like USD/JPY or the all-time favorite EUR/USD pair offers tight spreads and also faster execution speed. This makes entry and exit free of the slippage risks.
On the other hand, less liquid pairs comes with higher slippage and wider spreads. They may not be that useful for regular traders. Volatility, on the other hand, refers to the extent of price fluctuations. The more volatile the pair, the larger the profit the trader makes. Fast-action traders thus prefer highly volatile pairs like GBP/USD.
There are almost 180 currencies in the Forex market, but only the top 7 of them composes the most popular currency pairs due to their high liquidity. Highly liquid currency pairs like USD/JPY or the all-time favorite EUR/USD pair offers tight spreads and also faster execution speed. This makes entry and exit free of the slippage risks.
On the other hand, less liquid pairs comes with higher slippage and wider spreads. They may not be that useful for regular traders. Volatility, on the other hand, refers to the extent of price fluctuations. The more volatile the pair, the larger the profit the trader makes. Fast-action traders thus prefer highly volatile pairs like GBP/USD.
2: Trading Sessions and Market Hours
Timing stands second after liquidity as a vital factor for choosing the right currency pair to trade. Although the Forex market operates 24/7, there are certain times of the day when trading activities get higher. This is the times when multiple time zones overlap.
There are basically 4 major trading sessions;
There are basically 4 major trading sessions;
- Sydney Session 15:00 to 00:00 EST
- London Session: 03:00 to 12:00 EST
- Tokyo Session 23:30- 08:00 EST
- New York Session: 12:00 to 17:00 EST
3: Spread and Trading Costs
In high-frequency trading, the spread cost, or what we say the transaction cost, matters a lot. The chunks of payments that get chopped off while completing each trading action in Forex accumulate to be heavy on the total profit gain.
The spread is basically the difference between the bidding price and the asking price. If the difference is low, which means the spread is tight, then it is more favorable for frequent traders. But if the spread or difference is wider, then the cost of opening and closing a trade action will be higher.
Major currency pairs usually offer tight spreads due to their high liquidity and usability. On the other hand, exotic pairs, like USD/ZAR or USD/TRY, instead of having one highly liquid currency, often have wider spreads. Frequent traders, thus, need to be cautious of these extra costs of trading while choosing a pair.
The spread is basically the difference between the bidding price and the asking price. If the difference is low, which means the spread is tight, then it is more favorable for frequent traders. But if the spread or difference is wider, then the cost of opening and closing a trade action will be higher.
Major currency pairs usually offer tight spreads due to their high liquidity and usability. On the other hand, exotic pairs, like USD/ZAR or USD/TRY, instead of having one highly liquid currency, often have wider spreads. Frequent traders, thus, need to be cautious of these extra costs of trading while choosing a pair.
4: Correlation Between Currency Pairs
When trading in two or more currency pairs, the trader needs to consider the interrelationship between these pairs as well. Popular currency pairs can be either positively or negatively correlated with each other.
For instance, the EUR/USD and the GBP/USD are two currency pairs with positive relations. This is typically because both pairs have US dollars in common as the quote currency. Also, as the Euro and Pound are closely associated geographically and economically if any one of them strengthens/weakens, the other will likely deliver the same.
Choosing positive pairs thus can be risky, as in case of downfall, the effect will be multiplied for you. But choosing two or more inversely or negatively correlated pairs will be beneficial. For instance, the Euro and Swiss francs have historically shown inverse reactions against the fluctuations of the USD.
Thus, keeping USD as a base currency in one pair and as a quote currency in another can secure maximum profit. That is why spreading your trading in the EUR/USD and the USD/CHF pair can be risk-free in comparison to spreading in EUR/USD and GBP/USD.
For instance, the EUR/USD and the GBP/USD are two currency pairs with positive relations. This is typically because both pairs have US dollars in common as the quote currency. Also, as the Euro and Pound are closely associated geographically and economically if any one of them strengthens/weakens, the other will likely deliver the same.
Choosing positive pairs thus can be risky, as in case of downfall, the effect will be multiplied for you. But choosing two or more inversely or negatively correlated pairs will be beneficial. For instance, the Euro and Swiss francs have historically shown inverse reactions against the fluctuations of the USD.
Thus, keeping USD as a base currency in one pair and as a quote currency in another can secure maximum profit. That is why spreading your trading in the EUR/USD and the USD/CHF pair can be risk-free in comparison to spreading in EUR/USD and GBP/USD.
5: Fundamental and Economic Influences
Lastly, currency pairs are directly influenced by economic factors such as GDP and inflation rates. The monetary policies of major central banks like the Federal Reserve, the ECB, and even the Bank of Japan directly influence Forex algo trading.
Major geopolitical events, sanctions, wars, etc., also directly impact the values and rates of transactions in a particular currency. Therefore, understanding these fundamental factors is essential for effective trading in forex currency pairs.
Major geopolitical events, sanctions, wars, etc., also directly impact the values and rates of transactions in a particular currency. Therefore, understanding these fundamental factors is essential for effective trading in forex currency pairs.
Popular Currency Pairs and Their Characteristics
Here are the most popular currency pairs. Go through their category-wise divisions for better clarity.
1. Major Pairs (Most Liquid and Widely Traded)
- EUR/USD: It is the most popular pair without a doubt. Its high liquidity, narrow spreads, and consistent growth potentials make them most favorable.
- USD/JPY: It is known as the safe haven pair as it favors traders at times of market uncertainty.
- GBP/USD: It is another high volatility pair mainly due to the past UK politics and BoE decisions such as Brexit and the UK's exit from the EU.
- USD/CHF: The Swiss Franc is considered a safe-haven asset even by top economists due to the high value of the Swiss franc even in turbulances.
- AUD/USD: This is a commodity-based pair and is heavily affected by China's economy. China is a major commodity trading partner of Australia.
- USD/CAD: Its correlation with oil prices makes this pair attractive for traders focused on the energy market.
2. Minor and Cross Pairs (Less Liquid but Still Tradeable)
- EUR/GBP: It is heavily impacted by EU and UK relations.
- AUD/JPY: This pair is a bit risk-sensitive pair and follows global market sentiment.
- GBP/JPY: This is another high-volatility pair, extremely beneficial for for swing traders.
3. Exotic Pairs (High Risk, High Reward)
Exotic pairs, such as USD/SGD, EUR/TRY, USD/ZAR, etc., offer wider spreads with lower liquidity. Therefore, traders should be cautious about the economic stability concerns in emerging markets while trading in such pairs.
Choosing the Right Pair Based on Your Trading Style
The effectiveness of a forex pair often depends on the method of trading. For different trading ventures, different pairs thus emerge as the best currency pairs in Forex.
-> Scalping and Day Trading
The liquidity and tight spreads are crucial for scalpers and day traders. Pairs like EUR/USD, GBP/USD, and USD/JPY are ideal for this kind of trading because of high liquidity, minimal spreads, and frequent price movements.
-> Swing Trading
Swing traders generally trade pairs with well-established trends and highly volatile pairs. GBP/JPY, EUR/AUD, and NZD/USD are suitable pairs as they generate larger market swings.
-> Position Trading (Long-Term)
Long-term economic trends and interest rate differentials are what position traders focus mainly on. The pairs that depend more on broad economic trends, such as USD/CHF, AUD/USD, and EUR/USD, are thus more suitable for position trading.
Tools and Resources for Choosing Currency Pairs
Considering the complexity of the forex robot market, thus traders are often advised to follow and compare through different tools and resources before making their decisions here. Leveraging the below tools can help traders to take more informed steps;
- Using Forex Correlation Tools: There are different Forex correlation tools that give traders insight into the price moves of different pairs. For instance, DailyFX and Myfxbook are two popular correlation tools that provide you with real-time data to diversify your trading in pairs.
- Checking Economic Calendars: The Forex factory offers vital information regarding major economic events and their impact on ongoing currency trends. You can also check on the Investing.com site. You will get informed on upcoming major events such as central bank policy releases, GDP reports, inflation rate announcements, etc.
- Monitoring News Events and Central Bank Policies: Regular Forex traders can follow news channels like CNBC, Reuters, or Bloomberg to get instant updates on market conditions, and stances of different currency pairs. You can also follow these to understand central Bank policy changes, interest rate changes, etc.
- Leveraging Demo Accounts to Test Different Pairs: You can also begin with testing your moves through a demo account without risking real capital. Choose a Forex broker that provides a demo account with simulated funds for you to experiment and learn. This will build your confidence and refine your strategy before engaging in real live trading.
Common Mistakes to Avoid When Selecting Currency Pairs
Lastly, go through the common mistakes that often Forex traders make. This will make your trading ventures more effective;
- Ignoring Spreads and Transaction Costs: Traders often ignore the spreads by mistake. It is extremely important to note down the spread costs of different currency pairs, especially if you are opting for frequent trading. Choose a currency pair with tighter spreads for robust trading.
- Trading Exotic Pairs Without Understanding Risks: It often seems extremely lucrative to trade in exotic pairs due to the high-value differences between the two currencies. However, they often come with higher risks, such as lower levels of liquidity and wider spreads. These result in price slippage and higher transaction costs.
- Overtrading Multiple Pairs at Once: While diversifying investment in different and non-correlated forex pairs is often beneficial, you must know when to stop. Because trading in too many currency pairs at a time can lead to high confusion and wrong decision-making. Therefore, operate in only the number of pairs you are comfortable with.
- Not Considering Market Sessions and Timing: Trading in the most traded Forex pair without the knowledge of their suitable market hours can lead to missed greater opportunities. As the liquidity and volatility vary through different trading sessions, failing to align with overlapping time periods may cause you higher transaction charges.
Conclusion
Selecting the right currency pair to trade in the Forex market ultimately decides your profit range. Considering the above factors of liquidity, volatility, economic influences, and time-bound transaction charges. Through them, you will be able to make a more informed decision from now on. Whether focusing on the most popular forex pairs or experimenting with emerging ones, always back your decision with sufficient knowledge and thought.