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Base currencies are pivotal in the foreign exchange (forex trading) market as the reference point for all transactions. They serve as an anchor point, the first currency listed in each pair against which all others are quoted; therefore, they play an instrumental role in establishing exchange rate value and helping traders analyse and execute trades successfully.
Understanding the base currency is critical to forex traders as it determines their perception of a currency pair's value.
If the EUR/USD (euro vs US dollar) is trading at 1.3000, it stipulates that a trader would need 1.30 US dollars to purchase one euro.
If a trader speculates to execute a trade on the EUR/USD, the Euro, as the first listed currency would be the base currency in this currency pair example.
If a trader expects their base currency to appreciate relative to the quoted currency, they will buy (go long). Conversely, should they anticipate depreciation, they would sell (go short).
As per our earlier example, if the trader expects the euro to strengthen against the US dollar, the trader will buy euros and hope to sell back at a higher price later on. If the trader expects the euro to weaken against the US dollar, the trader will sell euros to buy back at a lower price later on.
On the foreign exchange (forex) market, a quote currency refers to the second listed in any given currency pair and represents its exchange rate; it often goes by other names such as the secondary currency or counter currency.
The quote currency is crucial for traders as it determines the price at which they can buy or sell a specific currency pair.
If USD/JPY (US dollar vs Japanese yen) is trading at 140.00, a trader will need 140.0 Japanese yen to buy one single US dollar.
In this example, if a trader wants to speculate on USD/JPY and execute a transaction, the Japanese yen would be the quote (secondary, counter) currency in this currency pair example.
A trader will buy (go long) if they expect their quoted currency to depreciate in relation to the base currency. In the event that they expect appreciation, they will sell (go short).
In our previous example, if the trader expects the US dollar to strengthen against the Japanese yen the trader would buy US dollars and hope to sell them back at a higher rate later. If the trader expects the US Dollar to weaken against the Japanese yen the trader sells US dollars with a view to buying them back at a cheaper price later.
Using the GBP/USD (1.2696) example - if the base currency (British pound) value increases or the quote currency (US dollar) value decreases, the quantity of US dollars required to purchase one Australian dollar will increase.
As the word “pairs” implies, currency pairs are traded in pairs. Although there are key differences between the base currency and quote currency; keep the following in mind.
You might find this article on forex market hours helpful.
When a trader buys a currency pair, they are buying the base currency and selling the quote currency. The base currency is the first currency while the quote currency is the second when reading a currency pair. Each plays an important role when quoting the price a currency pair is trading at.
When you buy a currency pair from a CFD broker, you buy the base currency and sell the quote currency.
In most cases, the US dollar is listed as the base currency. The EUR/USD is an excellent example of the US dollar taking the back seat as the quote currency. The reason behind this is primarily due to long-established customs and practices.
Using the USD/JPY currency pair as am example, the Japanese yen is the quote currency, and the exchange rate tells us how much one single US dollar is worth in Japanese yen.