The forex market is divided into 3 categories of FX pairs, based on the volume of trades. Understanding the differences between these groups of FX pairs is part of the knowledge any trader needs to have. A bit like a car dealer knows the differences between petrol, diesel, or electric engine cars.
The 3 types of FX pairs are defined by the size of the money mass (amount of money) in circulation, the importance of the economies, as well as the political stability of the country. Some attribution is often made to the size of the market in the currency pair. However, some exotic currency pairs trade more than some of the minor pairs.
These are all the FX pairs that include the US Dollar and one of the following 7 currencies:
The US dollar is the world’s leading reserve currency, and according to the Bank of International settlements (BIS), 88% of FX trades involve the US dollar.
These FX markets are possibly easier to trade as headline news about the currencies appears in most major outlets. Economic data is easy to access and of reliable quality. Bid offer spreads are also the tightest available, making entry and exit costs low compared to minors or exotics.
Minors or crosses involve any of the 7 currencies that compose one of the major FX pairs but exclude the US dollar. Usually, pairs are quoted, or have a position in the marketplace, because the currencies involved are related by commercial ties of the countries involved.
A common cross is the EUR/GBP, this is due to a large amount of commercial trade that takes place between the EU and the UK. Another common cross is the EUR/CHF or the EUR/JPY. Again, these are chosen as international trade means that importers and exporters are creating a demand for these currency pairs.
The exotics are made up of the US dollar and Euro against currencies from emerging countries, or what once used to be emerging countries, found in East Asia and Eastern Europe. The most traded exotic pairs include:
As with the crosses, currencies are paired off with currencies where substantial commercial trade is present. It would be very rare to find USD/TRY or USD/HUF quotes from a broker, and if you did the bid offer spread would be very wide.
Currency liquidity is an important factor when you consider which FX pairs you want to trade. Liquidity is about how often an FX pair trades, and how many participants are in the market. The higher both numbers are, the more a currency pair has liquidity.
The majors are the most liquid currency pairs in forex. This means that the bid offer spreads are very tight compared to other pairs. The most relevant factor for new traders is volatility, the major pairs have smaller price changes than exotics and most minors.
The US dollar is the most quoted and most traded currency in the world. The reason being is because it has the world’s largest economy and is used by most countries as the reserve currency. These factors determine that the US dollar is the most watched currency and the one that all major currencies trade against.
The biggest drawback in trading exotics is volatility. Some exotic currencies can trade within normal limits for extended periods. However, they are prone to scorching headline news that can cause changes in the price of up to 30% in just a day or two.
The next drawback for exotics is the typically wide bid offer spreads. These FX pairs tend to have small demand from importers and exporters and low liquidity. The pro of these markets is the reverse side of the volatility means you can trade much smaller amounts than you would with major pairs to gain the same profit or loss.
The choice for new traders should fall on the major pairs, given their large amounts of liquidity. These pairs offer relatively tight bid offer spreads and manageable changes in price. Minors and crosses can also be considered, mainly the EUR/GBP as it offers high liquidity and price stability.
As you progress with your trading and gain experience you may want to look at other minors and exotics. These pairs have more volatile price ranges and trading sizes should be scaled down to allow for sufficient room in your stop loss.
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