As retail traders, we need to understand how currencies are organized and under what regime governments and authorities manage them.
Our goal is to make money trading the forex market, therefore, selecting the best currency pairs to trade is vital to our success in this business.
In this article, I will define the G10 classification and describe the different currency regimes used by authorities and governments to manage their currencies.
The G10 currencies are ten of the most heavily traded and most liquid currencies in the world. The list includes the currencies of some of the world’s largest economies, such as the United States, EU, UK, Japan, and Australia.
The G10 currencies are:
- U.S. Dollar (USD),
- Euro (EUR),
- Japanese Yen (JPY),
- British Pound (GBP),
- Swiss Franc (CHF),
- Australian Dollar (AUD),
- New Zealand Dollar (NZD),
- Canadian Dollar (CAD),
- Swedish Krona (SEK),
- Norwegian Krone (NOK),
These currencies are among the most liquid forex pairs, meaning that traders can buy or sell them without significantly impacting their exchange rates. Due to their popularity, most major forex pairs consist of G10 currencies – such as AUD/USD, EUR/USD, GBP/USD, USD/JPY, USD/CAD, USD/CHF, and EUR/GBP.
What moves the G10 Currencies?
Before you start trading the G10 currency pairs or any other FX pairs, it is important to understand the factors that contribute to price movements. Professional traders understand that volatility creates opportunities in trading.
And with volatility comes high profit and high risk, which makes it important to learn what moves the forex market and how to apply strict money management to protect your capital from unnecessary losses.
The main drivers that influence G10 currency price movements are:
- commodity prices,
- Central banks and Government decisions,
- economic data releases,
- economic crisis and politics.
Also read about the major participants that move the Forex Market.
Commodity G10 Currencies
Some of the G10 currencies are heavily dependent on Commodities and therefore more volatile because they depend on one or two commodity prices.
There are four currencies in the G10 list that are correlated with commodity prices: the Australian Dollar, Norwegian Krone, New Zealand Dollar, and the Canadian Dollar.
The Australian dollar is positively correlated with gold and copper prices and therefore, any changes in gold or copper demand will impact the economy and the currency.
Similarly, the Canadian dollar is oil-linked because it is a net oil exporter, so any decline in the price of oil will often have a negative toll on the Canadian economy.
In the Forex market, we trade currencies in pairs. For example, when you buy US dollars you need to sell another currency in order to complete the transaction because you can’t buy US dollars with US dollars or Euros with Euros.
There are three types of currency pairs in the Forex Market: major, minor and exotic pairs.
Major Currency Pairs
Major currency pairs consist of the most frequently traded currencies in the world. The major pairs are the most liquid pairs in the market and have the lowest spreads (costs).
These pairs include:
- EUR/USD = Euro/US dollar,
- USD/JPY = US dollar/Japanese yen,
- GBP/USD = British pound/US dollar,
- USD/CHF = US dollar/Swiss franc,
- USD/CAD = US dollar/Canadian dollar,
- AUD/USD = Australian dollar/US dollar,
- NZD/USD = New Zealand dollar/US dollar,
As you can notice, every major currency pair has the US dollar on one side, because it is the world’s leading reserve currency and because the United States is the largest economy in the world involving about 88% of currency trades.
Minor Currency Pairs
The minor currency pairs are pairs that don’t include the US dollar. These pairs are called minor currency pairs or cross-currency pairs.
These are some of the minor pairs:
- EUR/GBP = Euro/British pound,
- EUR/AUD = Euro/Australian dollar,
- GBP/JPY = British pound/Japanese yen,
- CHF/JPY = Swiss franc/Japanese yen,
- NZD/JPY = New Zealand dollar/Japanese yen,
The most widely traded minors are those containing euro, British pound, and Japanese yen.
Exotic Currency Pairs
The exotic currency pairs include a major currency, such as (EUR, GBP or USD) and the currency of a developing economy such as (Brazil, Mexico or South Africa).
These pairs are not frequently traded and the spreads are higher compared to the major or the minor pairs.
Here are a few exotic pairs:
- EUR/TRY = Euro/Turkish lira,
- JPY/NOK = Japanese yen/Norwegian krone,
- GBP/ZAR = British pound/South African ran,
- AUD/MXN = Australian dollar/Mexican peso,
The Base and Quote Currencies
In Forex, currency pairs are written as Base/Quote:
The base currency is how much of the quote currency you will need to exchange one unit of it.
The quote currency is often referred to as the counter currency or the domestic currency.
For example, the EUR/USD currency pair, the Euro here is the base currency and the US dollar is the quote currency. A reading of EUR/USD = 1.25 means that 1 Euro equals $1.25. In other words, to purchase (or sell) 1 Euro you must pay (or get) $1.25 US dollar.
Exchange Rate and Currency Regimes
An exchange rate is the price of a domestic currency in terms of foreign currency. In other words, it is the amount of one currency you can exchange for another.
For example: CAD $1 = US $0.9050 = 90.5 US cents, here the base currency is the Canadian dollar and the quote currency is the U.S. dollar.
Floating Exchange Rates
Currencies under a flexible regime are controlled by the Government and the Central Bank. Most exchange rates are determined by the Forex Market. Such rates are called flexible or floating exchange rates.
The value of currency under this regime is supposed to be determined by the free market forces of supply and demand.
However, as we can see throughout history, as a result of War, International Competitiveness, Economic Crises and high levels of Government Debt can lead to direct intervention and mismanagement of the currency exchange rate.
When a government and or a central bank manipulates a floating exchange rate is to stop volatility in the exchange rate caused by economic shocks or speculation and to stabilize it to enable international trade through imports and exports.
When a government and or a central bank manipulates a floating exchange rate to the disadvantage of the other countries, it is termed as dirty floating.
Fixed Exchange Rates
When a country’s currency doesn’t vary according to the forex market, it has a fixed exchange rate. The government and central bank make sure that the currency’s value stays within a fixed range against major currencies.
For example, China maintains a fixed rate. Chinese central bank pegs its currency value to a targeted value against the U.S. dollar in the spot market.
In 2017, $1 U.S. was worth 6.806 Chinese Yuan compared to 8.28 back in 2003. The U.S. dollar has weakened because it can buy fewer Yuan today than it could in 2003. This has a huge impact on imports/exports between U.S. and China.
The U.S.-China trade deficit shows a huge imbalance favoring China. The United States spends more buying Chinese goods than it makes selling American-made products to China. As a result, China’s volume of exports to the United States largely outweighs its American imports.
The Yuan to dollar conversion is one of the most widely monitored exchange rates. These currencies are backed by two of the largest economies in the world.
Tradable Currency Pairs
As retail traders, we need to select the currency pairs to trade based on the following factors:
- Exchange rate regime (fixed or floating),
- Commodity dependency,
We have 46 currencies in total, 36 are floating and 10 are fixed regimes. This potentially limits our opportunities to 36 currencies in the spot market because fixed regimes mean the currency is controlled by the central authorities of the particular country to trade within very tight specific ranges.
17 of our floating currencies are non-commodity floating currencies meaning the countries do not have significant exposure in their exports to one or a multitude of global commodity prices:
US Dollar (USD), Euro (EUR), Swiss Franc (CHF), Japanese yen (JPY), British pound (GBP), Czech Koruna (CZK), Ukrainian hryvnia (UAH), Poland zloty (PLN), South Korean won (KRW), Taiwan New Dollar (TWD), Swedish Krona (SEK), Philippine Piso (PHP), Thai Baht (BHT), Vietnamese dong (VND), Hungarian Forint (HUF), Israel Shekel (ILS), and Romanian Leu (RON).
19 of our floating currencies are what is termed in the forex markets as Commodity Currencies meaning the countries have significant exposure in their Exports to one or a multitude of global commodity prices:
Australian Dollar (AUD), New Zealand Dollar (NZD), Canadian Dollar (CAD), Norwegian Krone (NOK), Egyptian pound (EGP), Kazakhstani Tenge (KZT), Indonesian Rupiah (IDR), Brazilian Real (BRL), Colombian Peso (COP), Peru Sol (PEN), Icelandic Krona (ISK), Russian Ruble (RUB), South African Rand (ZAR), Turkish Lira (TRY), Indian Rupee (INR), Malaysian Ringgit (MYR), Argentine Peso (ARS), Chilean Peso (CLP), and Mexican Peso (MXN).
By understanding how currencies are organized and under what currency regime they operate, we have taken the first step to separate ourselves from the rest of the crowd and increased our probability of profiting from the most potentially volatile pairs over the least potentially volatile.
Remember that with volatility comes opportunities.
Central banks and governments have the authority to manage their currencies by issuing monetary policies. These policies aim to protect the currency from high volatility and maintain economic stability.
Because not all currencies are the same, it is our job to learn under what regime these currencies operate and pay a close attention to what these authorities are doing in order to predict future price movements.