Decoding Currency Pairs: A Beginner's Guide to Reading Exchange Rates

Many people find exchange rates somewhat bewildering when they're first exposed to currencies through foreign exchange trading or overseas payments. Currency pairs pack a lot of information into a compact format, and once you know how to read them you can help yourself make smarter financial decisions as a traveler, investor, business, or everyday consumer.

Currency Pairs Explained

Currency pairs tell you the value of one currency against another currency. Currency pairs specify how much of one currency you need to buy a certain amount of another.

Why Currencies Are Quoted in Pairs

Currencies are quoted in pairs because the foreign exchange market revolves around exchanging one currency for another. When you trade currencies, you are simultaneously buying one currency while selling the other.

Each currency is only worth something when compared to the value of another currency. Currency values rise and fall based on market demand for one currency over another.

The Base Currency and the Quote Currency

Currency pairs are made of two separate currencies that work together. Each currency has a specific role in a currency pair. Once you know what each role is, you can understand exchange rates at a glance.

The first currency in any pair is known as the base currency. The second currency in a pair is known as the quote currency.

How to Read a Currency Pair

Currency pairs use short codes that represent different currencies. This allows banks and financial institutions to discuss currencies without confusion.

If an exchange rate is XX then that means it takes XX amount of the quote currency to buy one unit of the base currency. Remembering this will allow you to decode every currency pair you come across.

Common Currency Codes

International currency codes are standard across all banks and trading institutions:

• USD = United States Dollar
• EUR = Euro
• GBP = British Pound
• JPY = Japanese Yen
• INR = Indian Rupee

Understanding Exchange Rates

An exchange rate tells you how much of one currency you can buy with another currency. If the USD to EUR exchange rate rises, it could mean that the U.S. dollar has strengthened when compared to the value of the Euro, or that the Euro has weakened when compared to the U.S. dollar.

Exchange rates fluctuate constantly as investors and businesses buy and sell currencies based on current and expected economic conditions. Monetary policy, economic growth, trade activity, and inflation are some of the major factors that influence exchange rates.

Major Versus Minor Currency Pairs

Major currency pairs consist of the currencies from the world's largest economies. They typically have the following characteristics:

• Major pairs tend to be highly liquid
• Costs associated with trading are typically lower
• Information about these currencies is readily available
• Major pairs tend to be watched by traders all over the world

Minor pairs (also known as exotic pairs) are currency pairs that don't include the largest currencies. Because there is less demand to trade these currencies, spreads can be wider and movements can be more volatile.

Bid vs. Ask Prices

When you look at an exchange rate, you will likely see two prices. The bid price is the price that a buyer is willing to pay for a currency. The ask price is the price a seller is willing to accept when selling a currency.

The difference between the ask price and the bid price is called the spread. Banks and currency exchanges earn money by selling currencies at a slightly higher price than they buy them for.

Currency Pairs and the Traveler

Anyone that has ever traveled abroad has had some interaction with currency pairs. When traveling, currency pairs affect how far your money will go. By shopping around and understanding how exchange rates work, you may be able to save yourself some money.

Currency Pairs and International Businesses

For businesses that import or export goods abroad, understanding currency pairs can be critical to their bottom line. Fluctuating exchange rates can have an impact on how much businesses charge for their products, pay their suppliers, and even forecast budgeted revenue.

Practice Makes Perfect

Reading currency pairs isn't difficult, but like anything else it can take a little bit of getting used to. Once you understand the above information you'll find reading currency pairs pretty simple.