Anatomy of a currency pair

There are three components within a currency pair: the base currency, the cross currency, and the exchange rate or price where they intersect.

The nomenclature for many currency pairs are traditional within the forex trading market. They evolved over years of wholesale bank trading, and tend to list the stronger or higher value currency first. As the bank dealing desks evolved into the modern forex trading market, the currency pairs were standardised by the International Standardisation Organisation (ISO), and today the pairs are inflexible.

The base currency is the first one listed within the pair’s nomenclature, and it’s the currency being bought or sold during a transaction. For example, a trading planning to take the AUD/USD currency pair long will be buying the Australian dollar and selling its U.S. counterpart. A trader about to short the EUR/CHF pair will sell the Euro and buy the Swiss franc. This is referred to as the base, or notional, amount of the trade.

The cross currency, also known as the counter or secondary currency, is the second one listed, and it’s the currency that’s funding and denominating the transaction. When profits and losses accrue, they’re denominated in the cross currency, and must be exchanged for the trader’s domestic currency prior to withdrawal from the brokerage account. (Note that if the brokerage charges a fee for withdrawals, at least part of it covers the cost of that transaction.)

The exchange rate is where these two currencies intersect, and it’s the price, denominated in the cross currency, for buying or selling the base. As every experienced trader knows, when a brokerage offers a price on a currency pair, separate prices will be listed for buying (the bid) and for selling (the ask or offer), with the difference between them being known as the spread. The spread is the built-in commission for the brokerage’s services, and generally the only transaction cost the trader pays.

The exchange rate of a currency pair will fluctuate within the forex trading market in response to various influences, both technical and fundamental. Technical drivers include historical price action, chart patterns, and significant technical levels such as support and resistance or trendlines. Fundamental drivers include economic announcements, speeches or comments by central bankers, changes to regulatory regimes, and the overall global financial situation.

When the exchange rate of a currency pair rises, the base currency is strengthening against the cross currency. When the exchange rate falls, the base is weakening against the cross. Forex traders should determine which currency’s underlying domestic economy is improving or floundering, when considering the currency pair’s future direction and his resulting trades.