Currencies: Beyond Your Wallet

“The secret to being successful from a trading perspective is to have an indefatigable and an undying and unquenchable thirst for information and knowledge.”

-Paul Tudor Jones

Currencies play a large-than-life role in our daily existence and the world economy. As our primary means for exchanging value between parties, currencies are a vital part of trade between nations, commerce, income, savings, spending, and even investing.

More Than Just Cash in Your Wallet

While the currency you might be most familiar with is the cash in your wallet or purse, currencies are more than simply buying power. Their strength or weakness reflects many different characteristics including inflation, interest rates, government stability, laws and policy, geopolitics and economic activity. Unlike stocks which represent shares in a specific company, currencies are valued based on their relation to other currencies.

The currency market is global in nature and characterised as the most active financial market in terms of daily turnover volume (the amount of currency bought and sold). According to figures from 2016 compiled by the Bank of International Settlements, trading in currencies amounted to more than $5 trillion in value exchange hands daily. Its unique properties, including 24-hour a day operation 5 days a week, mean that there is no shortage of opportunities for ambitious traders. The big question that arises is how currencies are valued.

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Pairing Up to Determine Value

Measuring changes in currencies is not simply about measuring how much or little a currency is worth in local spending terms, but instead how its value changes against other global currencies. Currencies are therefore traded in pairs - the most popular of which is the Euro versus the US dollar, which is represented as EURUSD or EUR/USD in financial markets. The first currency in a pair is referred to as the base currency and the second currency is called the quote or counter currency. The pair describes how many units of the counter currency can be purchased with one unit of the base currency.

For example, if the EURUSD is quoted at a price of 1.2500, it implies that 1 Euro buys 1.25 US dollars. If the price of the pair rises, it means that the Euro is rising in value and the dollar is falling in value. The opposite is also true. If the price of the pair falls, the US dollar is gaining value and the Euro is losing value. However, gains and losses are relative because each currency is traded against numerous other currencies simultaneously in this round-the-clock marketplace.

While stocks are quoted to two decimal points, certain commodities, indices and currency pairs are typically quoted to four decimal points, with the normal unit of measurement referred to as a “pip.” A pip represents 1/10,000th of a point and is used to measure price changes in currency pairs. However, there are even smaller units of measure in certain cases. FXTM ECN Account holders may see trading platforms like MT5 quote currency pair changes to five decimal points instead of four, measuring changes in micro or mini-pips.

The Majors and the Minors

Currency pairs are generally categorised by the size of their role in the global economy, and are therefore broken down into major and minor pairs. The major pairs are comprised of any two of the following currencies: US Dollar, Euro, Japanese Yen, Pound Sterling, Canadian Dollar or Swiss France. All other currencies are considered non-major.

The minor pairs may also involve the US dollar but typically involve less frequently traded currency pairs, or those of countries with more limited trading volumes.

What Contributes to a Currency’s Value?

Whether US dollars, UK Pounds, European Euros, Japanese Yen, Chinese Yuan, or any other national currency, currencies change based on a variety of different factors. The three major factors that influence a currency’s value include interest rates, inflation and economic activity as a measure of gross domestic product (commonly referred to as GDP).

Positive economic data or policy decisions designed to support economic growth may help the value of a currency to appreciate against its peers. The opposite is also true. Slowing growth, high inflation which constricts economic activity, or falling interest rates may impact a currency negatively. However, none of these situations should be viewed as absolute.

A Few Final Thoughts on Currencies

The global currency market represents one of the crowning achievements of the last century’s globalisation efforts. Unlike many other assets, currencies are trading around the clock five days a week, responding to changing data and economic conditions in real-time and reflecting optimism or pessimism about a country’s outlook at any given time. Thanks to its unique properties, currency traders have a literal world of opportunities available at their fingertips.

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