Forex pairs explained for new traders

Curious about how forex trading works but not sure where to begin? Let’s start with the essentials: currency pairs. In this guide, we’ll walk through the basics of forex pairs and key terms you’ll need to know, setting you up to trade with confidence.

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What is a Forex pair?

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Imagine two currencies battling it out in a boxing ring. That's basically what a forex pair is – a matchup between two currencies, like the euro vs. the US dollar (EUR/USD) or the British pound vs. the Japanese yen (GBP/JPY). These pairs show you how much one currency is worth compared to the other.

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How to read Forex pairs

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In every forex pair, there's a "base currency" and a "quote currency." In EUR/USD, the euro is the base currency, and the US dollar is the quote currency.

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When you see EUR/USD = 1.1050, it means one euro can be exchanged for 1.1050 US dollars. This value constantly changes based on economic events.

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Types of currency pairs

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There are three key types:

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• Major Pairs: These involve the US dollar paired with major economies, like EUR/USD or USD/JPY. They are the most stable and commonly traded.
• Minor Pairs: Also known as cross-currency pairs, these don’t include the US dollar but involve other major currencies, such as EUR/GBP or AUD/JPY.
• Exotic Pairs: These pair a major currency with one from a developing or emerging economy, like USD/TRY or GBP/MXN. They tend to be more volatile.

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Forex pairs basics for beginners

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For beginners, it's best to start with major pairs, as they’re easier to understand and less volatile. As you gain experience, you can explore minor and exotic pairs.

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Pips: Small price movements

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You might hear traders talking about "pips". These are the smallest price movements in a forex pair, usually the fourth decimal place (except for Japanese yen pairs, where it's the second decimal place). If the EUR/USD price moves from 1.1050 to 1.1051, that's a change of 1 pip.

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Forex lot sizes: How much are you trading?

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When you trade forex, you trade in "lots." These are standardised amounts of currency:

• Standard Lot: 100,000 units
• Mini Lot: 10,000 units
• Micro Lot: 1,000 units
• Nano Lot: 100 units

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The lot size you choose affects your potential profit and risk.

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Pip value: Your profit calculator

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This is where it gets a bit mathy, but don't worry, it's simple. The pip value tells you how much you'll make or lose for each pip the price moves. It's calculated like this:

Pip calculation formula

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Pip Value = (Pip in decimal places) x (Lot size) x (Exchange rate)

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Pip calculation example

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Let's say you're trading a mini lot of EUR/USD (10,000 units) and the exchange rate is 1.1050:

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Pip Value = (0.0001) x (10,000) x (1.1050) = $1.105 (approximately)

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So, for every pip the EUR/USD moves, you'll gain or lose roughly $1.105. Remember that this will be in the quote currency! In this example, the quote currency is USD.

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What are spreads in Forex trading?

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The spread is like a fee on every trade. Think of selling a house for $500,000, but the agent charges a $10,000 fee. The buyer would need to pay $510,000 so you can still get $500,000. In forex, it's similar:

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• Bid: The highest price you can sell for (e.g. $500,000)
• Ask: The lowest price you can buy for (e.g. $510,000)
• Spread: The difference between the bid and ask prices (e.g. $10,000)

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How to calculate spreads in forex

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Let's say you see a quote like this for the USD/JPY pair:

• Bid: 112.50
• Ask: 112.55

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This means you can sell 1 US dollar for 112.50 yen or buy 1 US dollar for 112.55 yen. The spread is 0.05 yen (the difference between the bid and ask prices).

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Spreads can change depending on a few factors:

• Liquidity: Popular currencies often have high liquidity because they are traded in large volumes, which results in narrower spreads. In contrast, exotic currency pairs tend to be less liquid due to lower trading volumes, leading to wider spreads.
• Volatility: If the market is volatile, spreads might get wider. It's like a taxi driver raising prices during rush hour!
• Time of Day: Some trading sessions are more active than others, which can affect spreads.
• Your Broker: Different brokers offer different spreads.

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A smaller spread means lower costs for you. Market depth shows different bid and ask prices at various levels, along with how much currency is available at each price. This information can help you spot trends and make better trading decisions. 

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Understanding Forex pairs: The first step towards trading confidence

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Here's the key takeaway: understanding forex pairs, types, pips, lots, and bid/ask spreads is crucial for becoming a successful trader. They help you make sense of the market's movements and calculate your potential profits and losses. It's like learning the basic rules of the game before you start playing.

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Remember, knowledge is crucial in trading. Continue to learn with our free online courses and practice on a Deriv demo account, and you’ll soon find yourself navigating the forex market with greater confidence.

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Log in to Deriv Academy using your Deriv account email and password to get started.