In the forex market, currencies are always traded in pairs. Understanding how these pairs are structured, categorized, and related to each other is essential for developing effective trading strategies. This lesson explores the different types of currency pairs and how their movements correlate with each other and with other financial markets.

Currency Pair Structure

Every forex trade involves two currencies, with a consistent naming convention:

Base Currency/Quote Currency

• The base currency (first position) is what you're buying or selling
• The quote currency (second position) shows the price for the transaction

For example, in EUR/USD at 1.3000:

• EUR is the base currency
• USD is the quote currency
• The price means 1 euro costs 1.30 U.S. dollars

Types of Currency Pairs

The forex market organizes currency pairs into three main categories:

Major Pairs

Major pairs all include the U.S. dollar paired with another major global currency. They offer the highest liquidity and typically the tightest spreads.

EUR/USD remains the most actively traded pair, followed by USD/JPY. Major pairs account for approximately 80% of all forex trading volume.

Minor Pairs (Crosses)

Minor pairs (also called crosses) don't include the U.S. dollar. Instead, they pair other major currencies against each other.

Common examples include:

• EUR/GBP (Euro/British Pound)
• EUR/JPY (Euro/Japanese Yen)
• GBP/JPY (British Pound/Japanese Yen)
• AUD/JPY (Australian Dollar/Japanese Yen)

These pairs typically have wider spreads than majors but offer opportunities for traders who want exposure to specific economies without direct USD influence.

Exotic Pairs

Exotic pairs combine a major currency with the currency of a smaller or emerging economy.

Examples include:

• USD/PLN (US Dollar/Polish Zloty)
• EUR/HUF (Euro/Hungarian Forint)
• USD/HKD (US Dollar/Hong Kong Dollar)
• USD/SEK (US Dollar/Swedish Krona)

These pairs typically have:

• Lower liquidity
• Wider spreads
• Higher volatility
• Better suited for longer-term positions than day trading

Currency Correlations

Correlation measures how currency pairs move in relation to each other. Understanding these relationships helps manage risk and avoid inadvertently taking multiple positions that essentially represent the same market view.

Currency-to-Currency Correlations

Many currency pairs show strong correlations due to their shared components:

• EUR/USD and GBP/USD typically show positive correlation (move in the same direction) because both are quoted against the USD
• When the USD strengthens, both pairs generally move downward
• Trading both pairs in the same direction effectively doubles your exposure to USD movements

Currency-to-Commodity Correlations

Several currencies show strong relationships with commodity prices:

• Canadian Dollar (CAD) and crude oil prices show positive correlation
• • Canada is a major oil producer and exporter
  • Rising oil prices typically strengthen CAD (USD/CAD falls)
• Australian Dollar (AUD) and gold prices show positive correlation
• • Australia is a significant gold producer
  • Rising gold prices often strengthen AUD
• Japanese Yen (JPY) and gold often move together as "safe haven" assets
• • Both tend to strengthen during market uncertainty
• US Dollar (USD) and gold typically show negative correlation
• • Gold often rises when USD weakens
  • Investors may seek gold as an alternative store of value during USD inflation

Risk Management Implications

Understanding correlations helps prevent overexposure to particular market movements:

• Opening multiple positions in positively correlated pairs can multiply risk beyond intended levels
• Diversification requires selecting pairs with lower correlation to each other
• During major market events, correlations can strengthen, affecting even typically uncorrelated pairs

Key Takeaways

• Currency pairs follow a Base/Quote structure that determines what you're buying or selling
• Major pairs include the USD and offer the highest liquidity and tightest spreads
• Minor pairs (crosses) don't include the USD but pair major currencies together
• Exotic pairs combine major currencies with those from smaller economies
• Understanding correlations between currencies and with commodities helps manage risk
• Trading multiple correlated pairs effectively multiplies exposure to the same market forces