What is a foreign exchange rate?

FX Strategy Articles > Fundamental articles

The foreign exchange market works a little differently to the stock or commodity markets. Specifically, you cannot look at one currency in isolation to form an exchange rate. You must look at a currency in conjunction with another currency in order to form an exchange rate. Exchange rates are always expressed as a combination of two currencies.

Exchange rate example

For example, no price exists for the EURO by itself. However if you match the EURO with the USD you form the EURO/USD exchange rate. Similarly, if you match the EURO with the AUD you form the EURO/AUD exchange rate and so on. At the time of writing this article the EURO/USD exchange rate was 1.3126, which means that 1 EURO buys $1.31 USD.

The order in which the exchange rates are listed is important as well. In the example above we looked at the EURO/USD, however, an separate exchange rate exists for the USD/EURO. To find the value of the USD/EURO is straight forward once you know the EURO/USD as the number is the inverse of the USD/EURO. It is calculated as 1/1.3126 = 0.759. The interpretation is that one USD buys 0.759 EUROs.

What are the most popular cross rates?

The most popular cross currencies generally involve combinations of the USD, EURO, JPY and AUD. When trading combinations of these currencies (e.g. JPY/AUD or EURO/USD) the pip count (measure of brokerage) is usually much lower compared to trading exotic currencies. Often the mainstream currencies can also be traded at higher margin as well. 

Published on 12th of April 2011
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