Forex is the largest and most liquid market, with trillions of dollars traded between millions of parties around the globe each day. One of the first steps in understanding the market—which is also known as foreign exchange or currency trading—is to gain familiarity with some of the more commonly traded currencies. Here is a look at six major currencies, as well as the underlying traits and characteristics of each one.
Key Takeaways
- Forex trading is the world's largest and most liquid market.
- The U.S. dollar is the dominant currency in forex markets. The euro, Japanese yen, Australian dollar, Canadian dollar, and British pound are also actively traded currencies.
- The U.S. dollar is one side of many popular currency pairs and is also a reserve currency, making it first and foremost in the world of currency trading.
- The Japanese yen is the most active of the Asian currencies, due partly to the popularity of the carry trade.
1. The U.S. Dollar
The U.S. dollar, which is sometimes called the greenback, is first and foremost in the world of forex trading, as it is easily the most traded currency on the planet. The U.S. dollar can be found in a currency pair with all of the other major currencies and often acts as the intermediary in triangular currency transactions. This is because the greenback acts as the unofficial global reserve currency, held by nearly every central bank and institutional investment entity in the world.
In addition, due to the U.S. dollar's global acceptance, it is used by some countries as an official currency, in lieu of a local currency, a practice known as dollarization. The U.S. dollar also may be widely accepted in other nations, acting as an informal alternative form of payment, while those nations maintain their official local currency.
The U.S. dollar is also an important factor in the foreign exchange rate market for other currencies, where it may act as a benchmark or target rate for countries that choose to fix or peg their currencies to the dollar's value. China, for instance, has long had its currency, the yuan or renminbi, pegged to the dollar, much to the disagreement of many economists and central bankers. Quite often, countries will fix their currencies to the U.S. dollar to stabilize their exchange rates rather than allowing the free (forex) markets to drive the currency's relative value.
One other feature of the U.S. dollar is that it is used as the standard currency for most commodities, such as crude oil and precious metals. Thus, these commodities are subject not only to fluctuations in value due to the basic economic principles of supply and demand but also to the relative value of the U.S. dollar, with prices highly sensitive to inflation and U.S. interest rates, which can affect the dollar's value.
2. The Euro
The euro has become the second most traded currency behind the U.S. dollar. The official currency of the majority of the nations within the eurozone, the euro was introduced to the world markets on Jan. 1, 1999, with banknotes and coinage entering circulation three years later.
Along with being the official currency for most eurozone countries, many nations within Europe and Africa peg their currencies to the euro, for much the same reason that currencies are pegged to the U.S. dollar—to stabilize the exchange rate. As a result, the euro is also the world's second-largest reserve currency.
With the euro being a widely used and trusted currency, it is prevalent in the forex marketand adds liquidity to any currency pair it trades with. The euro is commonly traded by speculators as a play on the general health of the eurozone and its member nations. Political events within the eurozone can also lead to large trading volumes in the euro, especially in relation to nations that saw their local interest rates fall dramatically at the time of the euro's inception, notably Italy, Greece, Spain, and Portugal. The euro may be the most "politicized" currency actively traded in the forex market.
The U.S. Dollar is the dominant currency in foreign exchange markets. Measured by volume, the eight most common currency pairings involve the U.S. dollar.
3. The Japanese Yen
The Japanese yen is easily the most traded of Asian currencies and is viewed by many as a proxy for the underlying strength of Japan's manufacturing and export-driven economy. As Japan's economy goes, so goes the yen (in some respects). Forex traders also watch the yen to gauge the overall health of the Pan-Pacific region as well, taking economies such as South Korea, Singapore, and Thailand into consideration, as those currencies are traded far less in the global forex markets.
The yen is also well known in forex circles for its role in the carry trade (seeking to profit from the difference in interest rates between two currencies). The strategy involves borrowing the yen at next to no cost (due to low-interest rates) and using the borrowed money to invest in other higher-yielding currencies around the world, pocketing the rate differentials in the process.
With the carry trade being such a large part of the yen's presence on the international stage, the constant borrowing of the Japanese currency has made appreciation a difficult task. Though the yen still trades with the same fundamentals as any other currency, its relationship to international interest rates, especially with the more heavily traded currencies such as the U.S. dollar and the euro, is a large determinant of the yen's value.
4. The Great British Pound
The Great British pound, also known as the pound sterling, is the fourth most traded currency in the forex market. Although the U.K. was an official member of the European Union, the country never adopted the euro as its official currency for a variety of reasons, namely historic pride in the pound and maintaining control of domestic interest rates. As a result, the pound is sometimes viewed as pure-play in the United Kingdom.
Forex traders will often estimate the value of the British pound based on the overall strength of the British economy and the political stability of its government. Due to its high value relative to its peers, the pound is also an important currency benchmark for many nations and represents a very liquid component in the forex market. The British pound also acts as a large reserve currency due to its historically high relative value compared to other global currencies.
Being located in close proximity to the world's largest consumer base—the United States—the Canadian economy and the Canadian dollar are highly correlated to the U.S. economy and movements in the U.S. dollar as well.
5. The Australian Dollar
Also known as the Aussie, the Australian dollar is one of the major currencies of the Asia-Pacific region. The Aussie is considered one of the foremost commodity currencies, meaning that its value can be affected by price shifts in Australia's major exports.
The AUD-USD trading pair now accounts for 6.37% of global forex volume, beating the dollar pairings for both the Swiss Franc and the Canadian Dollar.
6. The Canadian Dollar
The Canadian dollar, nicknamed the loonie, is also a commodity currency, meaning that it often moves in step with the commodities markets—notably crude oil, precious metals, and minerals. With Canada being such a large exporter of such commodities, the loonie often reacts to movements in underlying commodities prices, especially that of crude oil. Traders often trade the Canadian dollar to speculate on the movements of commodities or to hedge positions in the commodities market.
The Bottom Line
Every currency has specific features that affect its underlying value and price movements relative to other currencies in the forex market. Understanding the factors that move a currency is a pivotal step in becoming a savvy participant in the forex market. The U.S. dollar, the euro, the yen, the British pound, the loonie, and the Swiss franc are major currencies to watch.
