Analyzing Currency Pairs

All financial engagements in the forex involve transactions between two currencies. A currency pair can be defined as a representation of the relation between two currencies.

The main components of a currency pair are the base currency and the quote currency. For instance, EUR/USD 1.2300 is understood as the Euro being the base currency and the U.S. Dollar as the currency being quoted against. In this case 1 Euro buys $1.23. As the figures go up, the dollar gets stronger, and vice versa.

The dollar is the standard by which all other currencies are usually quoted against, but there are situations when it is not involved, i.e., AUD/JPY (Australian Dollar / Japanese Yen). Forex currency pairs without the Dollar or Euro are termed cross rates.

When analyzing and examining currency pairs, it is important to remember that each pair has unique characteristics, and different technical studies must be employed.

As an example, consider the EUR/USD. It is the most widely traded currency pair in the forex, constituting almost 30% of the total market volume. Because it is affected by other currency pairs such as EUR/GBP and GBP/JPY (among other issues), the EUR/USD tends to be very liquid, making it an attractive option for short term forex trading.

The ideal technical indicators for the study of EUR/USD are the MACD (Moving Average Convergence Divergence), weighted and exponential averages, as these utilities emphasize newly acquired data. For determining any possible trends, DMI ( Directional Movement Indicator System) is preferred.

It should be stressed that due to the liquidity of this currency pair, a longer and wider period should be specified, regardless of the instrument being used, as short term periods are apt to give false signals.

Next to the EUR/USD in terms of popularity is the USD/JPY, and unlike the former, this forex currency pair is susceptible to long term trends, lending itself very well to trendline analysis. Short term trading is still possible, although to be profitable forex traders need to operate in more constrained time periods.

Among the most widely used technical indicators for the USD/JPY are Moving Averages (usually with a 21 day period).and candlestick charts, as they provide information on daily closing figures, essential to the USD/JPY. Momentum indicators such as RSI should be used with caution, as the USD/JPY has a tendency to move in a way that suggests a reversal when in fact it is going sideways.

A sound knowledge of currency pairs goes a long way towards helping forex traders, both novice and experienced. By applying the proper technical tools and studies, you will be able to manage the potential profits -risks- efficiently.