In a currency pair, like USD/EUR, when the base currency is the US dollar, the base currency is the first one named. The quotation or counter currency is the name given to the second currency. When you anticipate a gain in the base currency relative to the quote/counter currency, you are said to be "long" on the currency pair. You anticipate the reverse if you are "short" the pair.
Meaning and Illustrations of Base Currency
The primary currency in a currency pair is referred to as the base currency, while the second currency is known as the quote or counter currency. The exchange rate for a currency pair illustrates how much of the quote currency is needed to purchase one unit of the base currency.
Currency pairs are utilized because every transaction involves selling one currency while simultaneously buying another. When engaging in currency trading—typically for investment or speculative purposes—a long position indicates a belief that the base currency will appreciate relative to the counter currency.
Currency pairs are denoted by the abbreviated names of both currencies, with the base currency appearing first followed by the counter currency. Among the most actively traded pairs are the "major" currency pairs, with USD/EUR being one of the most prominent.
In the USD/EUR pair, the U.S. dollar serves as the base currency, while the euro acts as the counter currency. For instance, a quote of 0.8472 indicates that 0.8472 euros are needed to purchase one U.S. dollar.
The U.S. dollar functions as the base currency in many major currency pairs, including USD/JPY (Japanese yen as the quote currency), USD/CHF (Swiss franc), and USD/CAD (Canadian dollar).
How a Base Currency Works
Trading currencies involves taking a long position on the base currency while simultaneously taking a short position on the other currency. Various factors such as local shifts in interest rates, trade deficits, and economic growth can influence the preference for one currency over another.
Currency trading occurs on regulated exchanges known as Forex (short for "foreign exchange") as well as off-exchange markets.
Currency pairs are denoted in incremental units called "pips," with one pip representing the fourth digit after the decimal point in a quote, equivalent to 0.01% of one currency unit. For instance, if the quote is 0.8472, a movement of one pip would alter the quote to 0.8473 or 0.8471.
Similar to stocks, currency pairs have bid-ask prices. The buyer pays the ask price while the seller receives the bid price. Market makers earn the spread, which is the difference between the two prices. Exchanges strive to offer competitive spread prices to attract customers.
Trades are executed in "lots," each comprising 100,000 units of the base currency. Although this may seem like a substantial minimum investment, currency trading often involves margin requirements as low as 2% depending on the currency pair. Consequently, trading one lot with the base currency being dollars may only necessitate $2,000 in the account to control a trade worth $100,000.
What It Means for Individual Investors
When engaging in any currency pair trade, it is essential to comprehend the base currency due to the lot size as well as the fact that the base currency dictates the trade's direction (if you go long or buy the pair, you believe the base currency will appreciate in relation to the quote currency).
For instance, a trade including the US dollar as the base currency will be based on a $100,000 lot size; however, a trade involving a currency that is significantly worth more or less than the US dollar may significantly affect the margin need for your account.
How Base Currencies Are Read
Currency pairs, when given an exchange rate, show how much of the quoted currency is required to purchase one unit of the given base currency. For instance, €1 is equivalent to $1.55 when reading EUR/USD = 1.55.
A dealer must spend $1.55 in accordance with foreign exchange regulations in order to purchase €1. If a seller wishes to sell €1, they will receive $1.55 for it since the currency pair quotation is read in the same way as when selling the base currency.
Why Is It Called a Base Currency?
Currency pairs are used in foreign exchange transactions, where the base currency is one and the quote or counter currency is the other. Because it shows how much of a base currency is required to purchase one unit of the quote currency, the moniker "base currency.
Disclaimer
Derivative investments involve significant risks that may result in the loss of your invested capital. You are advised to carefully read and study the legality of the company, products, and trading rules before deciding to invest your money. Be responsible and accountable in your trading.
RISK WARNING IN TRADING
Transactions via margin involve leverage mechanisms, have high risks, and may not be suitable for all investors. THERE IS NO GUARANTEE OF PROFIT on your investment, so be cautious of those who promise profits in trading. It's recommended not to use funds if you're not ready to incur losses. Before deciding to trade, make sure you understand the risks involved and also consider your experience.
