By Stephen Lewing
Trading forex is hard, fun, risky, exhilarating, frustrating and potentially very rewarding.
You can maximize your chances of enjoying the positive side of the ‘game’ if you do your homework before parting with a single cent of investment, and this includes knowing exactly what it is you are trading.
It is worrying that a lot of newcomers to forex trading don’t even know that there are different types of currency pairs, and that their unique characteristics determine how they should be traded in the most efficient way.
How can you be successful if you don’t even know what you’re trading?
The forex pairs can typically be split into four categories – majors, minors, exotics and crosses – and the best trading brokers will let you open and close positions in each of these. You can read a LonghornFX review for one example of many firms that offer such a platform.
So, how do each of these forex currency pairs contrast with one another?
As you may have gathered from the name, the major forex pairs are those that are the most actively traded.
Examples falling under the ‘major’ tag include USD/GBP, USD/JPY and USD/AUS, and it’s no coincidence that those are some of the wealthiest countries on the planet (though it’s worth noting that some in the trading sector believe that any currency twinned with USD should be considered a major).
It should be noted that the major label is fluid, and there is no dictionary definition as to what makes for a major currency. Some general measures are considered – the GDP of the host country, whether it’s a reserve currency, whether there are constraints (China has a large and usually stable economy, for example, but its currency is state controlled rather than market led), and so on, but there are no defined parameters for major and minor pairs.
What is unique about trading the majors? Well, given how actively they are invested in, it’s no surprise to learn that liquidity tends to be high – this in turn is good news for investors, who are able to enjoy tighter spreads as a consequence and therefore better protect their profit margin.
Because the US dollar is the currency of choice when measuring world trade, the minors are considered to be any forex pairs that don’t have USD in them.
So, we would consider the UK and Japan to be ‘major’ economies, but in terms of forex trading, the GBP/JPY pair is known as a minor given the absence of USD.
Other examples of minor currencies include EUR, AUD and CHF, and while these are countries and zones of relative strength and wealth, they are not to be confused as majors when looked at from a forex perspective.
One of the main characteristics of trading minor pairs is that there tends to be less liquidity riding on them, and this can lead to greater volatility in their value. This is not to say that they can’t be traded successfully, but clearly there is more risk inherent.
Low liquidity also tends to mean wider spreads, so getting into – and out of – a trade at the right price is a task made more difficult.
Exotic forex pairs are those that have very limited interest from a trading perspective, and as such they are rarely considered.
You can, in theory, pair GBP with SEK if you want, but because this is not a consistently traded currency duo, you may find it very difficult to access value prices – and it may be even tougher still to close your position due to the cavernous spreads.
That said, swing traders can have their fun with exotic pairs, and so they aren’t completely disregarded as an option for more experienced investors who understand the inherent risks attached.
While given their own broad title, cross forex pairs are essentially minor in nature – i.e. they don’t include USD.
Years ago, traders would have to convert one currency into USD before converting that to the other currency in their pair – a complicated and time-consuming process.
Thankfully, direct market access has made this a thing of the past, with brokers now able to offer minor and exotic pairs without the administrative hassle. However, minors are still occasionally referred to as ‘crosses’ due to the cross-conversion process that used to occur.
Like with minor forex pairs, there are risks and rewards attached to trading crosses, so as ever, newcomers and the inexperienced are advised to do their homework before entering a trade with any forex currency grouping.
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