Types of Currency Pairs
To understand this you will first have to understand how is a currency pair formed and what does it tell you?
There are different countries in the world and they all have different currencies. The countries with a stronger economy have a strong currency and the country with a weak economy has a weak currency.
And as directly buying or selling of a currency is not possible in the forex market you have to do it in pairs.
Also normally in regular lives if you want to travel to a foreign country the first step is to exchange your base currency for the countries currency you are traveling to. Here again, you are buying and selling in pairs.
The same thing is true for the forex market, it's just that here you can buy or sell any currency pair directly with the currency of your account. Your broker directly lets you buy and sell any currency pair without an exchange fee and only charges an exchange fee if the trade is held overnight and this is called a swap.
So, there are different currency pairs in the forex market, and you buy and sell in pairs.
Let's understand what does this means?
Let us suppose there is a currency pair called EURUSD, in this pair when you want to buy USD, you will have to sell this pair (open a sell trade) and when you have to sell USD, you will have to buy this pair (open a buy trade).
There are different currencies in the world, out of which there are 8 major currencies like US dollar (USD), Euro (EUR), Japanese yen (JPY), British pound (GBP), Australian dollar (AUD), Canadian dollar (CAD), New Zealand dollar(NZD) and the Swiss franc (CHF).
These major currencies and several other currencies together form various pairs in the forex market
1. Major currency pairs
Now as I told you earlier that there are different currencies in the world and how they represent their economy.
Based on this factor there are 8 major currencies in the forex market.
1. US DOLLAR (USD)
2. CANADIAN DOLLAR (CAD)
3. EURO (EUR)
4. JAPANESE YEN (JPY)
5. BRITISH POUND (GBP)
6. AUSTRALIAN DOLLAR (AUD)
7. NEW ZEALAND DOLLAR (NZD)
8. THE SWISS FRANC (CHF)
Out of these currencies, the US Dollar is called the reserve currency of the world as it the most widely used currency and almost every financial system accepts it.
When the US dollar is linked with or paired with any of the major currency it is called a major currency pair. For example, EURUSD, GBPUSD, USDJPY, USDCHF, etc.
What are the features of major currency pairs?
1. High liquidity
The major currency pairs have dollar involved in it and as the USD is a reserve currency of the world and the most traded currency, the liquidity on all the major currency pairs is high. Meaning, there are more buyers and sellers in the market
When the liquidity is high the brokers are able to provide us with tight spreads. Also, there is no shortage of supply and demand in these pairs making them the trader's favorite pair to trade on.
2. High volatility
As there is continuous buying and selling with high volume involved the price of major pairs tends to change quickly. Therefore, it is said that the volatility is the market is higher than that of minor and exotic.
Why are major pairs important for forex traders?
Major pairs provide traders with high liquidity which in turn helps in quick transactions, low spreads and also provides high volatility.
Low spreads are very useful for the day traders and scalpers and hence most of the day traders and scalpers tend to trade major currency pairs.
2. Minor currency pairs
The currency pair which does not include USD in it is called a minor currency pair. These pairs don't have USD included but have the other major currencies involved for example GBPJPY, EURJPY etc.
What are the features of minor currency pairs?
1. Moderate liquidity
As minor pairs do not have us dollar involved in it the liquidity in minor pair is moderate. There are usually enough buyers and sellers in these pairs but not as many as of major currency pairs.
Mostly during the Asian session, the liquidity is very low and therefore the spreads are high during this time. During the most traded sessions like London and New York sessions, the liquidity is more and so the spread is low.
2. Moderate volatility
The volatility in minor pair is neither high nor very low.
3. Exotic currency pairs
The currency pairs which includes a major currency and currency of a developing economy like South Africa or India is called exotic currency pair. For example USDINR, USDZAR etc.
What are the features of exotic currency pairs?
1. Low liquidity
There are not enough buyers and sellers available in the forex market and hence the exotic currency pair is said to be the least liquid pairs. Due to this very reason, most traders avoid trading these pairs, and also the spreads on these pairs are very wide.
2. High volatility
Exotic currency pairs are considered more volatile because of low liquidity, along with unstable economic conditions in emerging economies.
There are very low buyers and sellers available in the market and the market fluctuations are very high as compared to minor and major currency pairs.