4 Ways to Trade Currency Pairs

Question: What's the largest, most liquid market in the world?

Answer: The foreign exchange (forex) market, where in 2022 a staggering $2.7 quadrillion in national currencies was bought and sold¹—roughly 17 times the trading volume of the U.S. stock market.²

Because you must always purchase one currency with another, currencies trade in pairs. If you believe the euro will strengthen against the dollar, for example, you would buy the EUR/USD pair; if you think the euro will weaken against the dollar, you would sell the EUR/USD pair.

While there are many ways to trade currency pairs, here we'll outline the basics and some strategies to consider when trying to participate in different market conditions.

First, some terminology:

• The base is equal to one unit of the currency you're buying and is always listed first in a pair.
• The quote currency is what you'll be using to buy it and is always listed second.
• The price quote is how much of the quote currency it would take to buy a unit of the base.

Let's look at the most common pair—EUR/USD—which in 2022 accounted for more than a fifth of all forex trading. Say the value of the euro (base) in relation to the U.S. dollar (quote currency) is 1.0708 (price quote). If you bought 10,000 units of the pair for $10,708 ($10,000 × 1.0708) and sold them a week later at 1.0950 ($10,950), your profit would be $242 ($10,950 – $10,708).

Currency pairs typically have minimum orders, which can range from 1,000 units for common currency pairs to more than 10,000 units for minor or exotic pairs—a steep cost of entry for many traders. However, you don't have to pony up all that money at once; most forex trading involves leverage, meaning you can establish a position in a large investment with a relatively small amount of money—typically 3% to 5% of the face, or notional, value.

It's important to remember, though, that leverage cuts both ways: It can magnify losses as well as profits. A small amount of market movement can have a large effect on your total profit and loss—you can even lose more than your initial investment—so you'll want to have an exit plan in place when trading currency pairs (see "Tread carefully").

For currency pairs that aren't heavily traded, low liquidity can create wide spreads between their bid and ask prices, and the price you pay or receive may be significantly different than what you were quoted. That's why you may want to focus on the most traded pairs that enjoy narrower bid/ask spreads—at least at the outset as you get comfortable with trading currency pairs.

Determining which currency pair to trade depends on several factors, including your time frame, risk appetite, and preference between fundamental and technical analysis.

Here are four common strategies to consider.

This fundamental-oriented strategy seeks to profit from long-term trend moves while ignoring short-term volatility. Traders employing this approach look for currencies from countries or regions whose central bank is either actively hiking or cutting interest rates, or a country that faces rising inflation, a slumping economy, or some other structural economic issue.

Since this approach requires holding a position for longer, it might be best to focus on pairs from countries with large differences in their federal interest rates. If your base currency is from a country with a higher interest rate relative to that of your quote currency, that's known as positive carry; you're basically borrowing money at a low rate to invest at a higher rate and pocketing the difference. (Negative carry, by contrast, subtracts from your profit.)

Any of the frequently traded pairs can be reviewed for position trading, so long as they maintain a positive carry. Historically, currency pairings with the Japanese yen could have made good position trading (and carry) candidates because the Bank of Japan has shown a willingness to hold rates lower for longer than other central banks. For instance, it famously held interest rates in negative territory for eight years, from 2016 through early 2024, in a bid to boost growth. This was in sharp contrast to many Western nations, which, other than during the pandemic, were either raising rates or holding them steady during the same period.

This technical strategy involves trading a currency pair with good momentum in one direction. Trend traders may look to identify currency pairs that are consistently trading above or below their moving average—the average closing price over a given time period—with the 200-day average being a popular choice. Because the trend can last for days or weeks, you need to have the patience to absorb small corrections that don't break the trend but might result in running an open loss. Of course, there's no guarantee that any trend will continue, so you must be prepared in case the price of the pair begins to break down.

Trend traders tend to favor the most heavily traded pairs because they often have established trends and deep liquidity. Currencies influenced by commodity prices—such as the Canadian dollar (oil and natural gas) and Australian dollar (minerals)—have historically trended as well.

This short-term strategy generally involves picking an upcoming event, such as a central bank decision or the release of key economic data, and taking a position on whether it will strengthen or weaken one currency over another. It can be risky since markets can be extremely volatile after news is announced, so having a stop order in place may potentially help protect your downside. Also, consider having firm profit targets in mind for an early exit before a possible reversal (see "Tread carefully").

In the past, major currency pairs with good liquidity have sometimes made for good targets because they have been less impacted by the widening spreads resulting from increased volatility. Their home countries also tend to produce a regular cadence of economic reports and rate decisions, providing historical data that may help you understand how the markets might react.

Day traders manage positions over a matter of minutes or hours, often with the aid of charting tools that can help identify support and resistance, plus breakouts and reversals, and may assist the technical trader with entry and exit points.

When looking for day-trading opportunities, you'll want pairs that have sufficient liquidity but also plenty of intraday price movements. However, keep in mind that frequent trading also increases transaction costs and can potentially increase losses and reduce any profits.

When trading currencies, consider the time of day you plan to be active, which is particularly important for day traders and swing traders. Due to the various time zones, the currency markets are open 24 hours a day from Sunday evening through Friday evening (Eastern time); if you aren't careful, the markets may move against you while you're away.

Finally, when trying out any new trading approach, consider honing your skills risk-free in paperMoney^®, a virtual trading experience that uses real-time market data. Once you're ready to trade the live market, start small and build your confidence with little wins before risking more of your capital to help minimize the penalty for getting your sea legs in what can be choppy waters.