Forex trading is the exchange of currencies in pairs. The fundamental principle is simple: when you buy one currency, you simultaneously sell another. In a currency pair like USD/CNY equals 7.1302, the first currency USD is called the base currency, and the second currency CNY is the quote currency. This rate means you need 7.1302 Chinese yuan to buy 1 US dollar.
Major currency pairs are the seven most traded currency pairs in the forex market, accounting for 80% of daily trading volume. These pairs include EUR/USD known as Euro, USD/JPY called Dollar Yen, GBP/USD nicknamed Cable, USD/CHF called Swissy, USD/CAD known as Loonie, AUD/USD called Aussie, and NZD/USD nicknamed Kiwi. Major pairs are characterized by extremely high liquidity, lower volatility compared to other pairs, resistance to manipulation, and very low trading costs due to their massive trading volumes.
Cross currency pairs are major currencies traded without the US dollar directly involved. However, USD still plays a crucial hidden role as an intermediary. For example, when trading EUR/JPY, the system first converts euros to US dollars using the EUR/USD exchange rate, then converts those dollars to Japanese yen using the USD/JPY rate. The most popular cross pairs include EUR/JPY, GBP/JPY, EUR/GBP, EUR/CHF, AUD/JPY, and NZD/AUD. These pairs typically have moderate liquidity, higher volatility than major pairs, and medium-range trading costs.
Exotic currency pairs involve at least one currency from an emerging market economy. These pairs are characterized by extremely high volatility and sensitivity to sudden political and economic changes. Examples include EUR/TRY, USD/TRY, USD/MXN, USD/ZAR, USD/SGD, USD/HKD, USD/THB, and USD/BRL. Exotic pairs have very low liquidity, making them easy to manipulate, and they require significantly higher trading costs compared to major or cross pairs. Due to their unpredictable nature and high risk, exotic pairs are recommended only for experienced traders with substantial risk management skills.
A pip represents the smallest price movement in a currency pair, typically the fourth decimal place. Understanding pip movements is essential for calculating profits and losses in forex trading. For EUR/USD, when the price moves from 1.2000 to 1.2001, that's a positive 1 pip movement worth 0.0001 US dollars. For USD/CNH, a movement from 7.1303 to 7.1302 represents a negative 0.1 pip worth 0.001 Chinese yuan. The monetary value of each pip depends on your position size, the pip movement, and the current exchange rate. This knowledge allows traders to precisely calculate their potential gains and losses before entering any position.