Lesson 3: How Do Traders Buy and Sell Currency Pairs?

No forex trader uses a singular currency in the forex market. That is against the principle of the forex market, which is buying one currency to sell the other. 

So, you must always quote a trade in pairs. That's where you can monetize the upward and downward price movements between the currency pair. 

Lesson Highlights 

• Forex traders can't trade with only a single currency; they must trade in pairs of currencies. 
• Political events, economic factors, and natural disasters are the three main drivers of currency movement.  

Currency Pairs: Major, Minor, and Exotic

Given the market's decentralization, forex traders can trade almost all global currencies. There are currently 180 legal currencies traders can use for forex trading.

When paired with one another, there would be tens of thousands of pairs. That would make picking which currency pair to trade much harder. 

However, there are classifications you can use when choosing a currency pair to trade. These are the major, minor, and exotic currency pairs. 

For the major category, the pair must be between the US dollar and another major currency. Major currencies belong to some of the world's strongest economies.

There are only seven major currency pairs:

The minor category includes the major cross-currency pairs. Crosses or pairings between the major currencies (except the USD) happen in the minor currency pair category.

Some examples of minor currency pairs are:

Lastly, the emerging global market belongs to the exotic currency pairs. Exotic pairs include one major currency and the currency of a developing country. 

Examples of these include:

How to Effectively Buy and Sell Forex

While there is no single correct way to trade forex, you can rely on the golden rule of trading: anticipating the rise and fall of a currency pair's exchange rate.  

But how do you anticipate the price movement?  

You can look at the market fundamentals to determine potential market movements. These fundamentals include the country's political events and economic policies.

1. Political Events 

The rise and fall of a market's value are highly related to the political events of the country it is in. By examining political events, you can anticipate changes in currency prices, make informed decisions, and capitalize on market movement.  

Here are the common events you should watch out for: 

• Upcoming elections 
• Changes in economic policy 
• Geopolitical conflicts 

Remember, if the event is positive, it will drive up the demand for the currency, which will lead to an increased value. 

If the event negatively impacts the economy, traders tend to stray away from the currency. The shift in demand will result in a decline in the currency value. 

2. Economic Factors 

A country's economic status goes hand-in-hand with its currency's value. Economic indicators can give you an idea of a currency's current state and how it would perform in the forex market.  

Here are the common economic indicators that help forex traders determine financial health and performance: 

• Fiscal policy 
• GDP (Gross Domestic Product) 
• Inflation rates 
• Monetary policy 
• Employment reports 

You can utilize the economic calendar to monitor these economic factors. The economic calendar gives you leads about the future economic events that impact the financial market.

Knowing how to maximize these economic factors should always be in your trading playbook. This knowledge helps you adapt to the fast-paced nature of a market economy. 

3. Natural Disasters 

Aside from the economic and political factors, the currency value will shake up during natural disasters. Natural disasters are among the common yet discarded risks in forex trading. 

Natural disasters are a wide range of catastrophes that a country might face. These can include:

• Earthquakes 
• Volcanic eruptions
• Floods 
• Hurricanes
• Climate change 

When a country experiences a super typhoon, that disaster hampers the country's economic growth and activities. That increases scarcity while reducing economic output due to damaged capital and infrastructure. 

Say there's a destruction of physical capital, then the country's GDP will regress. And remember, GDP is an important economic indicator that drives currency value. 

The extent of the disaster's damage disrupts the country's economy, which, in turn, impacts its currency's value and traders' confidence. 

Currency Correlation 

If you're not new to trading, you've probably noticed these two trends:

One currency pair rises while the other pair falls. 

or 

The same pair falls, and another pair follows suit. 

That trend is called currency correlation. You can make the most out of this trend when trading forex.

Currency correlation is the direct relationship between the movements of two currency pairs. There are two types of currency correlations: 

1. Positive correlation: The pair moves in the same direction.  
2. Negative correlation: The pair moves in the opposite direction.  

Analyzing the correlation between currency pairs will help you hedge your trades and balance out investment losses and gains. 

Also, imagine gaining profit with your open position. You can maximize that trend and open another position using a currency that positively correlates with your position. 

Note: There will be an instance where the two currency pairs do not correlate at all. This means that the currency movements are independent of each other.  

Correlation Coefficient 

The most common and accurate way to determine currency correlation is using the correlation coefficient.  

This statistical measure gives you an idea of the strength of the relationship between currency movements. The correlation is represented between the range of +1 to -1.  

• +1 implies that the currency movement between the pairs is perfectly correlated (positively correlated).  
• -1 implies a perfect inverse between the currency movement of the pairs (negatively correlated).   

Visual Chart Analysis  

For simple correlation analysis, traders also monitor the movement of both currency pairs using the chart.  

You can plot the two currency pairs on the chart. Set a period and observe their movement over time.  

If you notice that both currency pairs move in the same direction, then they are positively correlated. If the pairs move oppositely, the pairs have negative correlations.  

If the two movements are completely random, the pairs are non-correlated.  

In the next lesson, you'll learn more about the forex market and its liquid nature.

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