Popular Forex Currencies - Investopedia

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Popular ForexCurrenciesBy Brian currencies/default.aspThank you very much for downloading the printable version of this tutorial.As always, we welcome any feedback or pxTable of Contents1) Forex Currencies: Introduction2) Forex Currencies: Trading Strategies3) Forex Currencies: Ways To Trade4) Forex Currencies: The Four Major Pairs5) Forex Currencies: The EUR/USD6) Forex Currencies: The USD/JPY7) Forex Currencies: The GBP/USD8) Forex Currencies: The USD/CHF9) Forex Currencies: Commodity Pairs (USD/CAD, USD/AUD, USD/NZD)10) Forex Currencies: Currency Cross Rates11) Forex Currencies: Emerging Market Currencies12) Forex Currencies: ConclusionIntroductionThe currency markets are the largest and most actively traded financial markets in theworld with a daily trading volume of more than 3 trillion (Triennial Central Bank Survey2007). The majority of this trading is concentrated in the world's major financial centerssuch as London, New York and Tokyo. Large institutional investors such as banks,multinational corporations, hedge funds and central banks constitute the majority of themarket activity. To knowledgeably compete in this overwhelmingly institutionalmarketplace, individual investors need to assimilate as much information as possible.This tutorial provides an overview of basic foreign currency (forex/FX) trading strategies,the markets for those strategies, and an examination of some of the most popularcurrencies traded.Each transaction in the currency market involves two different trades: the sale of onecurrency and the purchase of another. The two currencies involved in the trade areThis tutorial can be found at: ncies/default.asp(Page 1 of 22)Copyright 2010, Investopedia.com - All rights reserved.

known as a pair. While it is possible to swap virtually any currency for another, themajority of trading occurs among a handful of popular currency pairs.MarketCurrency UD2.1%CAD1.6%Figure 1: The most heavily tradedcurrencies and their market shareSource: BIS Triennial Survey, 2004The chart shows the most heavily traded currencies and their market share. Totalmarket share adds up to 200% because each transaction involves two currencies (ECB:BIS Triennial Survey 2004).As the world's reserve currency, the U.S. dollar is the most actively traded currency, andpairs involving the dollar make up the majority of transactions. Therefore, this tutorialexamines the trading relationships between the U.S. dollar and several of its chiefcounterparts, including the euro, the Japanese yen, the British pound, and the Swissfranc. The tutorial also examines other popular trading pairs involving the U.S. dollarand the commodity currencies – those of Canada, Australia, and New Zealand.Although the average trader will likely participate only in trades involving the U.S. dollar,this tutorial includes a discussion of cross rate pairs – pairs of significant internationalcurrencies that are not the U.S. dollar. Additionally, because emerging markets form animportant part of the global financial system, this tutorial also examines the uniquechallenges facing individuals interested in trading emerging market currencies.(Formore information, read The Foreign Exchange Interbank Market.)Before the discussion of popular trading pairs, a brief analysis describes some of theinstruments, concepts and strategies that should be familiar to investors trading in thecurrency markets.This tutorial can be found at: ncies/default.asp(Page 2 of 22)Copyright 2010, Investopedia.com - All rights reserved.

Trading StrategiesFor beginning investors, there are a variety of currency trading strategies available.However, most strategies fall into two broad categories: hedging and speculating.HedgingWhen companies sell goods or services in foreign countries, they are usually paid in thecurrency of the country in which the sale occurs. But currencies can fluctuate, causingthe sale to be valued (in the home country) at less than hoped for or expected. To avoidpossible loss from fluctuating currencies, companies can hedge, or protect themselves,by trading currency pairs. Protection against the possibility of adverse currencymovement helps companies focus on generating revenues.Sometimes, traders in the international financial market hedge their foreign currencyexposures to gain as much as possible from their investments. A mutual fund managerwho wants to hold Japanese stocks, for example, may not want to be exposed tomovements in the Japanese yen. As the manager hedges against those movements,she secures "pure" exposure to Japanese stock price movements – exposureunhampered by fluctuations. These hedging activities constitute a sizable portion ofdaily currency turnover. As such, they are important for investors to understand. (Tolearn more, read A Beginner's Guide To Hedging and Using Interest Rate Parity ToTrade Forex.)SpeculatingThe activities of most investors will fall under the broad category of speculation, whichinvolves buying or selling a financial asset, usually in the face of higher-than-ordinaryrisk, in order to take advantage of an expected move. Speculators in the currencymarket wager that, in the future, the value of a currency will move higher or lowerrelative to another currency. In addition to individual investors, speculators in thecurrency market can include hedge funds, commercial banks, pension funds orinvestment banks. Currencies are traded in pairs, so in any given transaction, a trader iswagering that one currency will rise while the value of the second will fall. Most currencytrading occurs among a handful of very liquid and active pairs. Investors interested intrading these pairs need to formulate an understanding of the characteristics of thecurrencies involved and the factors that cause the movements between the currenciesthat constitute these pairs. Popular pairs will be covered in much greater detail later inthis tutorial. (For more insight, check out Using Currency Correlations To YourAdvantage and Finding Profit In Pairs.)Other Trading StrategiesIn addition to trades that focus upon the relative value between two currencies, thereare also other popular types of currency trades. In arbitrage trades, an investorsimultaneously buys and sells the same security (perhaps a currency) at slightlydifferent prices, hoping to make a small, risk-free profit. While this is obviously anThis tutorial can be found at: ncies/default.asp(Page 3 of 22)Copyright 2010, Investopedia.com - All rights reserved.

attractive proposition, arbitrage opportunities are very rare in efficient markets becausethere are many other investors also seeking to exploit these opportunities. Therefore,any arbitrage possibilities that do exist disappear quickly. Investors interested inarbitrage opportunities need to closely monitor market developments and actimmediately when opportunities appear. When opportunities are available, the pricedifferential is usually quite small. To generate a substantial profit, investors need totrade in sizes large enough to magnify the small price differentials. (To learn more aboutthis strategy, read Trading The Odds With Arbitrage and Arbitrage Squeezes ProfitFrom Market Inefficiency.)Another popular category of currency trade is the carry trade, which involves selling thecurrency of a country with very low interest rates and investing the proceeds in thecurrency of a country with high interest rates. In this category, the trader generates aprofit as long as the relationship between the two currencies is relatively stable. Thecarry trade is usually practiced by large, sophisticated investors (such as hedge funds)and is extremely popular during times of low market volatility. During high volatility, largefluctuations in the value of currencies and other financial assets can quickly overwhelmthe traditionally slow-and-steady profits found in the carry trade. Therefore, investorstend to shun the carry trade when market volatility rises. (Learn more about this tradein Currency Carry Trades Deliver and Profiting From Carry Trade Candidates.)Ways To TradeInvestors need to select not only a trading strategy and a currency pair but also amarket in which to trade. There are several markets available to currency traders,including the forex market, derivatives markets and exchange-traded funds.Trading ForexThe majority of currency trading takes place in the forex spot market. In the forex spotmarket, large banks and other financial institutions trade currencies among themselveseither for immediate delivery (spot market) or for settlement at a later date (forwardmarket.) Trades in the forex market occur over the counter, and the minimum size oftrades is very large. For these reasons, it has traditionally been impractical for individualinvestors to trade in the forex market.However, over the past several years, a new retail forex market has developed. Thismarket allows individual investors and small institutions to trade in the forex market insmaller volumes than those previously available. For the more heavily tradedcurrencies, bid-ask spreads are relatively narrow, and market liquidity can be excellent.Many currency brokerage firms will also allow investors high levels of leverage – insome cases 400:1 or higher. While the use of leverage can magnify investors' potentialreturns, it is important to remember that leverage also magnifies potential losses.Investors should carefully consider their risk tolerance before employing leverage. (Formore information concerning leverage in the forex markets, see Forex Leverage: AThis tutorial can be found at: ncies/default.asp(Page 4 of 22)Copyright 2010, Investopedia.com - All rights reserved.

Double-Edged Sword. For another viewpoint on leverage, also see Leverage's "DoubleEdged Sword" Need Not Cut Deep.)Because currency brokerage firms vary greatly in their resources, minimum accountsizes, available leverage and execution ability, investors should carefully evaluateseveral brokerage firms before opening a currency trading account. (To learn more, seeForex Basics: Setting Up An Account.)Derivatives MarketsDerivatives include futures, options and exotic, customizable derivative contracts. Whilethe more exotic derivatives are generally designed for institutional investors, individualinvestors often use futures and options.The most popular currency pairs have both futures contracts (that track the currencypair's movements) and options on those futures contracts. Individual investors can buyor sell the futures or the options to speculate on the direction of the currency pair. Thesefutures and options usually feature reasonably good liquidity, transparent pricing andmoderate capital requirements. For these reasons, futures or options are a viablechoice for individual investors interested in the currency market. (Learn more about thismethod of forex trading in Getting Started In Foreign Exchange Futures.)When using futures or options, it is very important to remain aware of the risks involvedin using these financial instruments. While large gains are possible, the majority ofinvestors using these securities eventually lose money. Additionally, futures contractscarry the possibility of potentially unlimited losses. Before employing a futures tradingstrategy, investors should carefully consider their risk tolerance and thoroughlyunderstand potentially adverse price movements.Exchange Traded Funds (ETFs)A relatively new addition to the currency trading universe is the exchange-traded fund(ETF). ETFs have been popular vehicles for tracking stock or bond indexes for manyyears, but ETFs that track currency movements are relatively new. A currency ETF canbe bought and sold just like any other stock. Investors who believe the currency is aboutto rise in price should buy the ETF; investors who believe the currency will decline invalue should sell the ETF. One advantage of ETFs is that they may be more familiar tothe average investor than the forex or derivatives markets. ETFs also carry strictermargin requirements, so they may appeal to more risk-averse investors. (Checkout Profit From Forex With Currency ETFs and Currency ETFs Simplify Forex Trades.)Indirect Currency ExposureForex investors should know that purchasing foreign securities exposes them to the riskof potential currency movements. Investors with no intention of directly trading foreigncurrencies, however, can benefit from a better understanding of the links betweenThis tutorial can be found at: ncies/default.asp(Page 5 of 22)Copyright 2010, Investopedia.com - All rights reserved.

international currencies – because these currency movements can ultimately affect thevalue of other financial assets.The Four Major PairsIn forex trading, four major currency pairs are the most popular: EUR/USD: The euro and the U.S. dollarUSD/JPY: The U.S. dollar and the Japanese yenGBP/USD: The British pound sterling and the U.S. dollarUSD/CHF: The U.S. dollar and the Swiss francThese pairs are discussed in the following segments, along with the role of eachcurrency in the economy of its country (and the world) and the factors affecting thecurrency's movement. (Learn more about how pairs are traded in Finding Profit InPairs.)The EUR/USDThe United States and the European Union are the two largest economic entities in theworld. The U.S. dollar is the world's most heavily traded and most widely held currency.The currency of the European Union, known as the euro, is the world's second mostpopular currency. Because it is made up of the two most popular currencies in theworld, the EUR/USD