What it means
In a pair written EUR/USD, the euro is the base currency and the US dollar is the quote currency. If the price is 1.1000, one euro costs $1.10.
Buying the pair means buying the base and selling the quote, and selling the pair means the reverse. Pairs fall into three broad groups.
Major pairs involve the US dollar and another widely traded currency, such as EUR/USD, GBP/USD or USD/JPY, minor or cross pairs do not include the dollar, such as EUR/GBP, and exotic pairs combine a major currency with one from a smaller or emerging economy. The groups matter because liquidity and cost differ.
Major pairs trade in enormous volume and usually have the narrowest spreads (the gap between the buying and selling price), while exotic pairs cost more to trade and can move erratically. Prices are usually quoted to four decimal places, and the smallest standard move is called a pip, which is 0.0001 for most pairs.
For pairs involving the yen, the pip is normally the second decimal place, 0.01, because the yen has a much lower unit value. For businesses, the pair determines how an invoice, a payment or a balance sheet item is translated.
A company that sells in euros and reports in dollars is effectively long EUR/USD, so a fall in the pair reduces the dollar value of its European revenue. The nuance that trips up beginners is direction.
A rise in EUR/USD means the euro has strengthened against the dollar, which is the same as the dollar weakening against the euro, so every move is both a gain for one currency and a loss for the other.
In practice
Real-world examples.
Example
A US exporter invoices a German customer 80,000 euros. The finance team checks the EUR/USD rate on the invoice date to book the sale at $88,000 when the pair is at 1.1000, and revalues the receivable at month end.
Example
A UK holiday company pays its hotel suppliers in US dollars. It watches GBP/USD because a drop in the pair means it needs more pounds to buy the same number of dollars.
Example
A Singapore manufacturer imports parts from Japan in yen and pays staff in Singapore dollars. It uses the cross rate between the two currencies, which is calculated from each currency's rate against the US dollar when no direct quote is available.
Formula
Calculation
Value in quote currency = amount of base currency x exchange rate
Pip value for a standard lot (100,000 units of base) = 100,000 x 0.0001 = $10 when the quote currency is the US dollar
Suppose EUR/USD is quoted at 1.1000 and a US company needs to convert 50,000 euros. The dollar value is 50,000 x 1.1000 = $55,000. If the pair then rises to 1.1200, the same 50,000 euros is worth 50,000 x 1.1200 = $56,000, a gain of $1,000 in dollar terms.
That $1,000 is a move of 0.0200, or 200 pips, on a 50,000 euro position. At about $5 per pip for 50,000 euros (0.0001 x 50,000), 200 pips x $5 = $1,000, which confirms the result.Case study
Seen in the real world.
Brightwater Foods is an illustrative, fictional US company that sells specialty sauces to supermarkets in Europe. Its sales team quoted prices in euros, while the head office reported results in dollars.
When EUR/USD fell from 1.1500 to 1.0500 over a year, the same euro revenue of 4,000,000 euros was reduced from $4,600,000 to $4,200,000. Sales had not dropped at all, yet reported revenue fell by $400,000, and management briefly assumed a demand problem.
Once the finance director split the movement into volume and currency, the picture became clear. In this illustrative case, the company began reporting a constant-currency figure alongside the reported one, so the board could see what was a market change and what was an exchange rate effect.
Watch out
Common mistakes.
- Reading the pair backwards, when EUR/USD at 1.10 means one euro costs $1.10 and not the other way round.
- Assuming a rising pair is good for everyone, when it is good for the holder of the base currency and bad for a buyer who needs to purchase it.
- Using the quoted rate as the rate you will actually get, when real transactions occur at the bank's bid or offer rate which includes a spread.
Questions
People also ask.
What does the slash mean in a currency pair?
It separates the base currency on the left from the quote currency on the right, and the price tells you what one unit of the base costs in the quote currency.
Which pair is the most traded?
EUR/USD is widely regarded as the most heavily traded pair, which is why its spreads are generally among the narrowest.
How do I find a cross rate?
Divide or multiply two dollar-based rates so the dollar cancels out, for example EUR/GBP can be derived from EUR/USD divided by GBP/USD.
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