Trading 101: Introduction to Currency Pairs, Part 1
Trading fiat and crypto-currencies involves an awful lot of simple and not so simple technical terms to learn. One of the most basic ones is the term “currency-pair” which comes from the fact that you always compare (and trade) a currency to another when you are talking about the “price” of it. That’s right, there is no such thing as trading the Dollar or Bitcoin or ETH in itself (let’s forget about the currency indices and more complex assets for now). You can, of course, be a holder of Dollars, Bitcoins, or ETH tokens, but to value and trade them, you need to have something to compare it to.
Now, this when it can get complicated and confusing for beginner investors and traders, as sometimes different people mean different things when they talk about the price of a currency. We will take a look at the basic conventions concerning both traditional and cryptocurrencies, and how to interpret the various currency pairs. For those who are already familiar with forex trading and international exchange rates, this article might seem too simplistic, but for those who are new to the field, it’s absolutely essential to understand the basic terms.
The Fiat Convention
Long-term chart of the EUR/USD, the most traded currency pair
In the fiat world, the most commonly used base currency is the US Dollar, the largest global reserve currency. It’s not only widely used to process international transactions but it’s also the guideline for valuing all the different international currencies. So, when someone says that the Euro is getting stronger, it usually means that it’s appreciating compared to the USD.
Now, this where it makes sense to introduce the term of currency pairs, as the Euro’s value against the Dollar is commonly referred to as the EUR/USD pair. The basic format for currency pairs is always this, a ratio of the three letter abbreviation of the currencies involved. We have to add that the major currencies are valued on several pairs against each other, as is the case with the Euro and the Great British Pound (EUR/GBP pair), the Japanese Yen (EUR/JPY pair) and so on.
Also, in some regions of the world, where another currency is dominant, that currency might serve as the common base for the local currency pairs (like the Euro in Europe). The convention usually involves only one way of calculating a pair, although it makes total sense to talk about the USD/EUR pair (and all the other inverse pairs) as well.
Conventions in The Crypto World
The cryptocurrency segment is growing exponentially, both in the capital involved and the number of currencies that are present. The valuing convention is much more fluid here than in the traditional Fiat world, which could lead to severe practical problems.
The basic currency of the crypto-world is Bitcoin, as most of the altcoins are valued in BTC-terms, although Ethereum is rapidly gaining ground, while the inherited Dollar-pairs are also widely used. We wouldn’t cast our vote for a future convention here, especially that having more pairs to trade and value coins is better for traders and investors alike. That said, we suggest always using pairs when discussing currencies, as it could save you and others from a lot of troubles.
The relative performance of the ETH/USD, the BTC/USD and the ETH/BTC pairs so far in 2017
The key element of using pairs in trading is to understand relative performance. As Bitcoin has exploded in value against the USD, altcoins generally followed it higher, and what’s more a lot of them (think Ethereum) have gained significant ground even on Bitcoin. Translating that to the language of pairs and the example of the ETH token, the ETH/USD pair has stellar gains this year and even the ETH/BTC pair is up several 100%s in 2017.
To be clear Ethereum provided way more profits for those who held it against the Dollar (or want to use it the fiat world), as Bitcoin itself surged compared to the USD. But, that doesn’t mean that holding ETH/BTC is a bad idea, just you have to know that you basically remove the Dollar (so the fiat world) from the equation, so the profits you bank will be entirely coming from Ethereum’s (or any other coins) relative performance compared to Bitcoin.
In the second part of the introduction, we will show you how to use currency pairs to your advantage in investing and trading. And if there is anything that’s not clear, please don’t hesitate and put it down in the comments below, so we can clear all doubts there or in the next article.