The foreign exchange market is the most liquid of the capital markets with approximately $5 trillion in notional value traded every day. Currency trading occurs around the clock, active 24 hours a day, six days a week. The most liquid currency pairs are the major currency pairs. They provide traders with the tightest bid/offer spreads and allow investors to enter an exit with very little slippage. The most liquid and widely traded of the major currency pairs are the EUR/USD. Approximately 28% of all forex trading occurs in the EUR/USD currency pair.
With that in mind, here are some basics to help familiarize new investors on the basics of forex trading:
Forex Trading Basics
The forex markets function around the clock, providing access to the capital markets 24 hours a day. However, forex trading generally occurs in three time zone subsets. The Asian time zone gives way to the European hours where the activity is generally the greatest, which gives way to the North American time zone.
The security that is traded in the forex market is a currency pair. The price is an exchange rate. The exchange rate describes the rate where you could exchange one currency for another. The first currency in the pair is referred to as the base currency. The second currency in the pair is referred to as the counter currency. The exchange rate tells you how much of the counter currency is needed to purchase one unit of the base currency. For example, if the EUR/USD is trading at 1.09, the exchange rate tells you that you need 1.09 US dollars to purchase 1, Euro. Some standard rules that surround which currency is the base currency and which is the counter currency.
What are the Major Currencies?
The most liquid currencies are the major currencies. A major currency pair includes the Euro, the Japanese yen, the British pound, the Swiss franc, the Canadian dollar, and the Australian dollar. These currencies, when combined with the US dollar, are considered major currency pairs. The pair must include the US dollar to be considered a major currency pair. If the pair includes two major currencies but not the US dollar the pair is referred to as a cross-currency pair.
What is Liquidity?
The major currency pairs provide the most liquidity. Liquidity is the ability to exchange an asset for cash. It also refers to the likelihood that you can sell an asset quickly and realize the market price.
When you compare the total volume of all currency transaction you will find that the EUR/USD has the most volume of all the currency pairs. Approximately 28% of all the currency transactions traded are EUR/USD. The USD/JPY follows with approximately 13% of the total volume followed by 11% for the GBP/USD, 6% for the AUD/USD, 5% for the USD/CAD, and 5% for the USD/CHF. These elevated levels of volume tighten the bid-offer spread.
What is the Bid-offer Spread?
One measure of liquidity is the spread between where market makers are willing to purchase a currency pair, called the bid, and where market makers are willing to sell a currency pair, called an offer. A tighter spread generally reflects greater levels of liquidity.
The Bottom Line
The currency market is an active market that provides access 24 hours a day, 6 days a week. The most active currencies are the major currencies. Of the major currency pairs, the EUR/USD is the most liquid which allows investors to enter and exit with very little slippage. The bid-offer spread on the Euro is also generally the tightest, making this currency pair one of the most popular trading instruments.
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