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Currency pair and counter-party risk

Forex traders analyze currency pairs to make trading decisions. Whether it's the Eur/usd, Usd/jpy, Gbp/cad, they all have the same basics you have to understand. There are different dynamics for a currency pair to pay attention to which will assist you in making trading decisions.

The main points are

• Currency pair basics.
• Counter-party risk.

What Is A Currency Pair?

A currency pair consists of two currencies, hence pairs, weighed relative to one another. There are two important parts to a currency pair, the base & quote.

The base currency is ALWAYS equivalent to 1

The quote currency is quoting you how much it will take to get you one unit of the base.

In the Eur/Usd example above, we have the bid(1.0998) and ask(1.1000). The bid is what the market will buy from you, the ask is what the market is offering.

If you decide to buy 100,000 units of the euro at 1.100, you would have a total trade value of \$110,000.

100,000 X 1.100= \$110,000 trade value

You are buying 100,000 units of the base currency with the anticipation the Euro will appreciate relative to the US Dollar.

Example: The Euro/Usd moves from 1.1000 to 1.1010. This is a 10 pip increase or .0010(subtract 1.1000 from 1.1010)

The base(Euro) increased to 10 pips against the Usd. This would be reflected in the chart as a bullish(up move)  currency pair.

Counter-party risk

When you are looking at a currency pair, you can think of it as two currencies sitting on a teeter totter. The stronger currency is going to make the price move in that direction. This depends on what currency is the Base & Quote.

There is counter-party risk involved when trading Forex. Since a Forex pair has two currencies, one of those currencies could be moving the pair, or both!

For Example! IF..

The Euro was strengthening and Usd was flat, price(Eur/Usd) would rise(bullish) BUT..

If the Euro was flat and the Usd was weakening, price(Eur/Usd) would rise(bullish)

Imagine this..

The Euro was strengthening when the Usd was weakening. Price(Eur/Usd) would rise dramatically! This is called divergence! Ferocious moves happen when this type of divergence plays out! It's good for us traders!

This is the same for bearish markets as well. You would just flip the examples from above. Give it a try!

Conclusion

Counter-party risk is important when it comes to your trading. Do you want to maximize returns and know what currency is moving the pair? Understand the dynamics of how a pair moves in Forex.

This is why at Top Traders we use custom currency indexes. It is one of the edges.. The indexes are evenly weighed against all the major currencies, therefore we know what currency is strong and what is weak.

Don’t treat a currency pair as one when you have two currencies involved. Remember counter-party risk!

Posted
April 3, 2020
in
Forex Basics

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