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Discover how the world’s largest and most liquid financial market operates. We explain how international currencies are traded and give you the key facts you need to know before you enter this popular market.
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The most popular currency pairs, such as EUR/USD, USD/JPY and GBP/USD, are known as the majors. You’ll often hear them referred to by short nicknames, such as ‘cable’ for the GBP/USD pair – a reference to the transatlantic telegraph cable which originally transmitted the exchange rate.
Pairs which are traded less frequently are known as minor currency pairs. You may also see them called cross-currency pairs or currency crosses. The most popular minor pairs tend to contain the euro (EUR), sterling (GBP) or the Japanese yen (JPY).
You may also come across pairs containing one major currency along with another from a small or emerging economy; these are known as exotic pairs, or exotics for short. Examples include GBP/MXN (sterling and the Mexican peso) or USD/PLN (US dollar and Polish zloty).
Other forex classes, such as Australasian pairs and Scandinavian pairs, group pairs along regional lines. These classes set currencies from their respective regions against one another, or pair them with others from around the world.
There are a number of factors which affect the forex markets:
Interest rates set by central banks have the most influential role in moving currency prices. Since currencies are the representations of a country’s economy, differences in interest rates affect the relative worth of currencies in relation to one another.
An increase in interest rates might encourage traders to invest (in general) within that market, causing the demand for the currency to rise. Investors are likely to buy assets denominated in high-interest currencies as these offer a higher yield on their investment.
However, a rise in interest rates also means that money is more expensive. This makes investment opportunities less favourable if money needs to be borrowed, and can put the brakes on demand for currency.
A fall in interest rates may discourage investors (in general) from purchasing assets in that economy, because it reduces their return on investment. This can lead to weaker demand for the economy's assets, and cause its currency to depreciate in value.
However, a fall in interest rates also makes it cheaper to borrow money, and this can make investment opportunities more appealing and boost demand for the currency.
Announcements such as GDP figures, unemployment levels and manufacturing data can have a profound effect on forex markets because they affect confidence in a country’s economic stability.
For example, if US unemployment is high, this can reduce confidence in the US dollar, encouraging investors to sell the currency. If investors are inclined to sell rather than buy, this pushes down the price of the dollar against other currencies.
Forex prices are not only affected by developments in the base currency’s home country. For example, an announcement that the Chinese government intends to build more factories is likely to increase the value of the dollar, as investors would expect US companies to receive orders for building materials such as steel.
Each individual trader will have a personal opinion about the direction of the forex market, but market sentiment represents how the majority of market participants feel the market will perform.
When making decisions, forex traders gauge market sentiment as well as make use of more scientific methods such as technical analysis. Find out more in our technical analysis module.