Currency Pairs Explained (Major, Minor, Exotic)

If you've taken a look at a Forex trading platform, you may have noticed that currencies are always presented in pairs - EUR/USD, GBP/JPY, USD/CHF, etc - which can be confusing. Why pair two currencies, and what does the order of the currencies mean? The answers to these questions go to the heart of the foreign exchange market.

Knowing about currency pairs is much like learning the alphabet before you can write; it is the basis of everything you are going to do as a trader. You will find that there are three different types of currency pairs - major, minor, and exotic - which you will learn about in detail, on top of understanding how to read the market, with less ambiguity than half a lifetime of novice experience.

What is a Currency Pair?

In Forex, you never buy or sell one currency on its own and always trade one currency against another currency. That is why you will see currencies quoted in pairs, like EUR/USD. The first currency is called the base currency, and the second currency is called the quote currency (or counter currency). The price of the pair tells us how much of the quote currency it takes to buy one unit of the base currency. So, if EUR/USD was trading at 1.1000, this means that 1 euro was worth 1.10 US dollars.

Currency pairs enable traders to speculate on the relative value of one currency versus another, rather than its absolute value.

Major Currency Pairs

Definition

Major currency pairs are some of the most frequently traded pairs in Forex, and they always include the US dollar (USD) either as the base or quote currency. The major pairs are preferred due to their liquidity, tighter spreads, and general price stability compared to less frequently traded pairs.

Examples of Major Pairs:

• EUR/USD (Euro / US Dollar)

• GBP/USD (British Pound / US Dollar)

• USD/JPY (US Dollar / Japanese Yen)

• USD/CHF (US Dollar / Swiss Franc)

• USD/CAD (US Dollar / Canadian Dollar)

• AUD/USD (Australian Dollar / US Dollar)

• NZD/USD (New Zealand Dollar / US Dollar)

Why Retail Traders Like Them

Major pairs have huge daily trading volumes, resulting in faster order fill times and tighter spreads (the cost to enter the trade), and they also respond as expected to macroeconomic news; therefore, they are great for beginner traders and experienced traders.

Minor Currency Pairs

Definition

Minor currency pairs are also referred to as "cross currency pairs" or just "crosses", and they exclude the US dollar and extend to the Icelandic krona or whatever currency you want to add to your watchlist!

Examples of Minor Pairs:

• EUR/GBP (Euro / British Pound)

• EUR/JPY (Euro / Japanese Yen)

• GBP/JPY (British Pound / Japanese Yen)

• AUD/JPY (Australian Dollar / Japanese Yen)

• CHF/JPY (Swiss Franc / Japanese Yen)

Why Retail Traders Like Them

Minors still offer good liquidity, particularly the highly traded EUR/GBP and EUR/JPY pairs. They can be advantageous for traders focusing on the relative relationship between two economies, specifically in terms of their external influences, and here you aren't seeing that US influence. For instance, if you are expecting the euro to strengthen against the British pound, based on the European Central Bank making a change in monetary policy, then EUR/GBP might be your pair.

Exotic Currency Pairs

Definition

Exotic currency pairs consist of a primary currency paired with a currency from an emerging market or smaller economy. Exotic currency pairs are typically more volatile and less liquid than currency pairs that consist of majors or minors. Exotic currency pairs have wider spreads.

Examples of Exotic Pairs:

- USD/TRY (US Dollar / Turkish Lira)

- USD/SEK (US Dollar / Swedish Krona)

- USD/ZAR (US Dollar / South African Rand)

- EUR/PLN (Euro / Polish Zloty)

- USD/THB (US Dollar / Thai Baht)

Concerns Stemming from Exotics

Exotic currency pairs can exhibit large price swings with potential for big profits, but they also come with significant risks. Exotic currency pairs have low liquidity, which translates into wider spreads and increased probability of slippage. Exotic currency pairs are often more sensitive to local political or economic occurrences, which may trigger sudden, unpredictable moves.

How liquidity varies by pair

Liquidity, the relative ease of buying or selling a currency pair, is highest in major pairs, moderate in minor pairs, and lowest in exotic pairs. Liquidity impacts not just the speed of order execution, but also the cost of trading.For example:

- EUR/USD can have a spread as small as 0.1 – 0.3 pips in active hours,

- EUR/GBP can be slightly larger at 0.5 – 1 pip, and

- USD/TRY, while not necessarily worse, can have spreads of 10 pips or more in certain market conditions.

Factors Affecting Each Category

• Majors: Global economic events, and market sentiment related to the US dollar or central banks' decisions

• Minors: Regional or territory-focused economic relationship, trade balance, or rate differential

• Exotics: Politics, commodity prices, or reliance on those commodities and flows of capital

Choosing Which pairs to trade

In your consideration for which pairs to trade, you should examine your own risk tolerance and trading style:

- If you are a beginner, then majors generally are better to begin with since they are still predictable and will cost less.

- If you would like to familiarize yourself with another currency, i.e., focusing on opportunities without a USD influence, then minors are a good stepping stone.

- If you are experienced enough to handle more volatility and price movement, then you can find rewards with exotics, but please be sure to have risk management in place.

Practical Tips for Trading Currency Pairs

Know The Active Hours - Each pair has active times during the day when liquidity is most significant, which often lines up with overlapping trading sessions.

Follow Economic Calendars: A key economic release from one country related to another can be impactful when trading a pair.

Position Size for Volatility: You should consider the optimal position size for exotic pairs, given the potential for larger price movements.

Test Strategies on a Demo Account: Testing new pairs with strategies you have devised live or on a demo account can help you confirm your primary approach.

Common Mistakes Beginners Make

- Spreading yourself too thin by trading too many pairs can limit your ability to follow the news and will not allow for attention to technical signals.

- Pair correlations- for example, the EUR/USD and GBP/USD have shared movements since they use the same government currencies.

- Not understanding the risk that comes with exotic pairs can expose you to bigger losses.

Closing Thoughts

Understanding the framework for major, minor, and exotic currency pairs involves more than just knowing what's on the list, but understanding their behavior and what drives their moves, as well as how they will factor into your trading strategy. Majors can give you liquidity and stability, while minors offer you a non-USD level of diversification, and exotics offer volatility, which could accompany rewards.

By understanding how each category of risk behaves and identifying the one that suits your personal risk appetite, you can significantly improve your ability to navigate the Forex market.

Ultimately, the key is not to try to trade every pair, but to own a few and truly know everything there is about them, as that is what will generate consistent results; not chasing every market glide...but simply trading meaningfully and with informed reason.