Base Currency – Forex Explained
Currencies in the Forex market are always quoted in pairs: base and quote currency. The quote currency is also known as the counter currency.
The base currency plays a vital role in foreign exchange rates and transactions. Moreover, it determines the rise and fall of currency pair prices on Forex. Thus, it has a direct impact on gains and losses and buying and selling. Its buying price and its selling price also determine the spread.
For inexperienced traders, this terminology may be confusing. However, it’s very important to understand what it is in a Forex quote and its importance in Forex transactions.
Also, there are many trading platforms that help you to understand better, or you can find a forex broker for more information.
What is base currency?
As we already mentioned, Forex quotes are always made up of two currencies. The base appears to be the first of the pair. For example, in the USD/JPY quote, USD is the first currency mentioned; thus, it represents the base currency.
The abbreviations for currencies are determined by the International Organization for Standardization – ISO. The codes for forex market currencies are specified in standard ISO 4217. Foreign exchange markets use these three-letter codes to represent a specific currency. Currencies that make part of the currency pair are separated with a slash.
The currency that is purchased or sold in relation to another, known as the quote currency, is known as the base currency. It always has a value of 1.
Consider that you are considering the USD/JPY pair. A quote of 125.3 indicates that 1 USD is equivalent to 125.3 Japanese Yen.
Due to its stability and its status as the quintessential commercial currency, the US dollar is generally quoted as the base currency. Consequently, there are USD/JPY, USD/CAD, USD/CHF, etc. Alternatively, it will be indicated in the EUR/USD, GBP/USD, and AUD/USD pairs as the counter currency.
Whether the base currency is the US dollar or another currency, it plays a vital role in Forex transactions.
The role in Forex transactions
The base currency is essential in Forex transactions. Actually, for currency buying transactions, it is the purchased currency. In a sell transaction, the base currency is sold.
The quote is up when the base increases while the quoted currency depreciates. On the other hand, a decline in the price quoted means that the base currency has lost its value. Therefore, it influences, in one way or another, the gains and losses in Forex.
As a Forex trader, you have the possibility of taking a long or short position.
Opening a long position means that you expect the base currency to rise or the quote currency to fall.
If you go for a short position, you expect the base currency to fall against the quote currency. For instance, if you expect that USD will fall in value or that the euro’s value will rise, you will buy EUR/USD.
The real challenge in Forex is to anticipate and predict trends in currency prices. Here again, the first part of a currency pair is a decisive factor. Being able to anticipate the evolution of currency pairs is undoubtedly the key to success in Forex. Therefore, the trader must make a judicious choice of the currency pair he wants to speculate.
Then, using analysis tools, the Forex trader can forecast the price trends. Good anticipation of the evolution of the base currency is practically a guarantee of gain. On the other hand, a wrong forecast can be disastrous and lead to losses. If you are a newbie trader, it’s not advisable to speculate on exotic currencies because of their instability, making the fluctuation of their price difficult to predict.
Influence on spread
The base currency is also important for determining the spread. In Forex, the spread is the difference between the buy price and its sell price.
For example, if the EUR/USD pair is quoted 1.4035/1.4039, the euro’s buy price is 1.4035, and its sell price 1.4039. The spread will therefore be equal to 1.4039-1.4035 or 4 pips. The PIP represents the broker’s commission.
All in all, the base currency has a definite influence on the gains and losses of traders. It is of capital importance in Forex trade in the sense that it determines the rise or fall of prices.