Tuesday, March 24, 2015

Base currencies and counter currencies

When you look at currency pairs, you
may notice that the currencies are
combined in a seemingly strange
order. For instance, if sterling-yen
(GBP/JPY) is a yen cross, then why
isn’t it referred to as “yen-sterling”
and written “JPY/GBP”? The answer
is that these quoting conventions
evolved over the years to reflect traditionally
strong currencies versus
traditionally weak currencies, with
the strong currency coming first.
It also reflects the market quoting
convention where the first currency
in the pair is known as the base currency.
The base currency is what
you’re buying or selling when you
buy or sell the pair. It’s also the
notional, or face, amount of the
trade. So if you buy 100,000 EUR/JPY,
you’ve just bought 100,000 euros and
sold the equivalent amount in
Japanese yen. If you sell 100,000
GBP/CHF, you just sold 100,000
British pounds and bought the
equivalent amount of Swiss francs.
The second currency in the pair is
called the counter currency, or the
secondary currency. Hey, who said
this stuff isn’t intuitive? Most important
for you as an FX trader, the
counter currency is the denomination
of the price fluctuations and,
ultimately, what your profit and
losses will be denominated in. If you
buy GBP/JPY, it goes up, and you
take a profit, your gains are not in
pounds, but in yen.

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