A guide to EUR/USD forex trading
The EUR/USD is the currency pair covering the European Union and the United States of America. The Euro acts as the base currency and the US dollar acts as the quote currency. If you’re unfamiliar with how base and quote currencies work, the quote currency states how much is required to buy one unit of the base currency.
How do you trade the Euro and the US Dollar? Simple: you enter the forex market and take a position on the EUR/USD currency pair. This guide will outline the basics of forex trading, how currency pairs work, and some important things to know before you begin trading the EUR/USD forex pair.
What is forex trading?
Forex is a word made from Foreign Currency Exchange. From this, you can already begin to understand what forex trading involves. The forex market is a place where global currencies, such as the Euro and US Dollar, are exchanged. To facilitate this process of exchange, currencies are grouped together in pairs. So, when you’re trading forex, you’re actually trading the value of one currency against another.
A lot of people will have already engaged in some type of forex exchange, even if they’ve never traded before. How? By going on holiday to a foreign destination. When you convert your native currency for the one used in the country you’re travelling to, that’s a type of forex exchange. You’re using your currency to buy another.
The foreign currency you’re buying has a price that fluctuates. This means you can only buy as much of it as your native currency allows at that moment. This is also how forex trading works. Prices are set by comparing one currency to another.
What are currency pairs?
Forex trading is the act of exchanging one currency for another at a particular price. This process of exchange can only take place by putting currencies into pairs. These pairs compare the price of the base currency to the price of the quote currency.
When you look at a currency pair, the base is the first one listed (on the left of the slash), and the quote is the second currency listed (on the right of the slash).
So, for the EUR/USD pair, EUR is the base currency, and USD is the quote. Why do you need to know what the base and quote currencies are?
You need to know which currency is the base and which one the quote is because that’s how a value is assigned to the pair. The mechanics of a currency pair are: you’re looking at how much of the quote currency you need to buy one unit of the base currency. Let’s put this into an example.
Let’s say the price for EUR/USD is 1.3000. This means you can exchange 1 EUR for 1.3000 USD. Now, because we’re thinking about how much of the quote currency you need to buy one unit of the base currency, these numbers need to be flipped. Doing that allows us to say you need 1.3000 USD to buy 1 EUR.
To make this even easier to understand, let’s remove the decimals. If the EUR/USD price is 1.3000, we can multiply that by 100 and say you need 130 USD to buy 100 worth of EUR. Regardless of whether you choose to think about the price comparison in decimals or whole numbers is up to you. The point here is that the price you see refers to the amount of quote currency you need to buy one unit of the base currency.
The buy and sell price
Complicating things slightly, forex brokerages display two prices: the Buy Price and the Sell Price. The Buy Price is the rate you’ll get if you want to buy the currency pair i.e. go long. The Sell Price is the rate you’ll get if you want to sell the currency pair i.e. go short.
There will be a small difference in the value of these two prices. This difference is known as the “Spread” and it’s where brokers cover their costs. Spreads are measured in pips. Pip stands for Point in Percentage and it’s the smallest standardised movement of a currency price. You can click hereto learn more about forex trading for beginners. This will tell you all about pips, spreads, and price movements.
As a trader, you need to decide whether the currency pair’s price will increase or decrease. Based on that decision, you will either take a Sell position or a Buy position.
Buy Position: If you think the value of the base currency will increase compared to the quote currency, you’d take a Buy position. So, for EUR/USD, taking a Buy position means you believe the price of EUR will strengthen against USD (or USD will weaken against EUR). Expressed in another way, you believe EUR will be bullish against the bearish USD.
Sell Position: If you think the value of the base currency will decrease compared to the quote currency, you’d take a Sell position. So, for EUR/USD, taking a Sell position means you believe the price of EUR will weaken against USD (or USD will strengthen against EUR). Expressed in another way, you believe EUR will be bearish against the bullish USD.
Major currency pairs
There are major currency pairs, such as EUR/USD, minor currency pairs, and exotic pairs. Forex is the most liquid market in the world, which means the major pairs attract a lot of trading activity. As such, there are plenty of opportunities to buy or sell. You can trade over 190 currency pairs at Saxo, and some of the major ones are:
- EUR/USD
- USD/JPY
- GBP/USD
- USD/CHF
- AUD/USD
- USD/CAD
Why does the EUR/USD forex pair matter?
The EUR/USD is the most traded of all forex pairs in the world. That’s largely because it is the two biggest western economies trading against one another. One of the key differentiators between the value of the Euro and the US dollar is their respective interest rates. The rates set by the European Central Bank (ECB) and the Federal Reserve can play an influential role. Meanwhile, any issues affecting EU nations, such as the past debt crises in Italy and Greece, did much to destabilise and weaken the EUR/USD, with the dollar strengthening fast against the Euro.
The risks of trading EUR/USD
Trading any type of financial instrument carries a certain amount of risk. Forex can be volatile. Measuring price movements in pips means that even the smallest change can have an impact on your trade. This is something novices don’t always understand because it’s easy to mistake currency exchange rates with what happens in the forex market.
When you go to a bureau de change and look at the EUR/USD exchange rate, you’ll typically only see two numbers after the decimal point because that’s how we look at monetary values. So, on one day, you might be able to get 1.35 US for 1 EUR. The next day you might be able to get 1.36 USD for EUR. This doesn’t seem like a big jump and, in many ways, it’s not.
In forex, things are different because more numbers after the decimal point are taken into account. It’s these micro-movements that make forex trading a volatile activity. Therefore, when you’re assessing the risks of EUR/USD, you need to think about how significantly and frequently the price will change.
Don’t forget about leverage
Another risk you need to consider when trading EUR/USD is leverage. Forex pairs are traded in lots and a standard lot is worth 100,000 units of currency. Therefore, unless you have that much money, you need to use leverage to trade on a margin. This means you put up a small amount of the total cost and the broker leverages up your investment. The difference between your investment and what the broker lends you is the margin.
You can choose the amount of leverage you take. The less you take, the more money you have to stake. However, in most cases, you’ll trade EUR/USD with a margin. That’s fine because it allows you to enter positions. However, leverage will magnify your profits and losses because your position is based on the full value of your trade and not just the money you committed. Therefore, when you lose money on a leveraged trade, you can lose it faster.
To stop the losses from consuming your entire stake, you need to use stop-loss limits. This tool will automatically close a position once a certain loss limit is reached. That makes it an important tool to use when you’re trading EUR/USD. It won’t stop you from losing money on a bad trade, but it can limit your losses. As long as you accept this, as well as the other risks associated with forex, there is potential in the market. EUR/USD has high liquidity and, with the right analysis and trading conditions, it’s possible to make a profit.
