29 April 2024 - 11min Read
In the forex market, currencies are always traded in pairs; the first is the base currency, and the second is the quoted currency. The base currency always has a price of one, while the quoted currency’s price states how much is needed to buy one unit of the base currency.
This concept of base and quote currency forms the foundation of every currency transaction.
There are many different currency pairs, each traded against each other with price valuations constantly changing.
However, due to the sheer number of currency pairs available, traders take notice of only a handful of currency pairs; most of these will fall under the category of major currency pairs. But we’ll go over that a bit later in the article.
Currency pairs are identified by their three-letter ISO (International Organisation for Standardisation) code.
The first and second letters of a currency pair indicate the country of origin, while the third letter indicates the currency’s name. For example, GBP is the Great British Pound, and USD is the United States Dollar.
In this article, we’ll have an in-depth look at the difference between the base currency and the quote currency. We’ll also provide various examples and important factors that might be imperative for novice and seasoned professional traders alike.
Marc Aucamp
Content Writer
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The base currency is the first currency listed in a forex currency pair and acts as the reference point for all transactions within the forex market. This is because, in the forex market, one currency is always quoted in relation to another; when you buy one currency, you’re simultaneously selling another.
The base currency plays an instrumental role in establishing the exchange rate value of a currency pair while helping traders analyse the market to potentially execute trades successfully.
Understanding the base currency could be essential to forex traders because it determines their perception of a currency pair’s overall value.
Let’s take GBP/USD as an example; with this currency pair, GBP (Great British pound) is the base currency, and USD (United States dollar) is the quote currency.
Now, let’s say that GBP/USD is trading at 1.2100; what this means is if a trader wants to buy one pound, they would have to pay 1.21 US dollars.
When trading forex, a trader has the option to trade both long (buy) and short (sell) positions.
If they expect the value of the base currency to appreciate, they could open a long (buy) position. Or, if they expect the value of the base currency to depreciate, they could open a short (sell) position.
Let’s use the example mentioned earlier again; if a trader predicts the value of GBP will rise against the US dollar, they could buy pounds with the hopes of selling it back later at a higher price, thus potentially making a profit.
On the other hand, if they predict the value of GBP will decrease against the US dollar, they could open a short (sell) position and buy it back later at a lower price, thus potentially making a profit.
Let’s look at some of the important factors that every trader might want to note regarding base currency.
As previously mentioned, forex currencies are always presented in pairs, and the second currency is what’s known as the quote currency. The quoted currency represents the exchange rate and what buying one unit of base currency will cost.
When looking at a forex chart, the price listed for any forex currency pair will always be the quoted currency price. The quote currency is essential for traders as it determines the price at which they can buy or sell a specific currency pair.
If we take the currency pair USD/CAD, the base currency is the US dollar, and the quoted currency is the Canadian dollar.
Let’s say, for example, that USD/CAD is trading at 1.3100; this means a trader would need to pay 1.31 Canadian dollars to buy one unit of US dollars.
If a trader predicts the price of the quote currency will depreciate, they could open a long (buy) position. In contrast, if they predict the price of the quoted currency will appreciate, they could open a short (sell) position.
As we saw earlier, this is the opposite of what will happen if a trader looks at the base currency when opening a position.
If we take our example as mentioned earlier, if a trader believes the Canadian dollar will appreciate in value against the US dollar, they could sell US dollars to buy it back at a lower price with the hopes of potentially making a profit.
Now, if they believe the value of the Canadian dollar will depreciate against the US dollar, they would buy US dollars and sell them back at a higher amount with the hopes of making a profit.
A trader will still buy or sell US dollars in this instance because you’re always looking at the base currency when opening a trade because the base currency acts as the anchor point for the two currencies.
Let’s have a look at some of the important factors regarding quote currencies below.
There are hundreds of different currency pairs in the forex market, and each can be categorised into one of three groups: majors, minors, or exotics. Let’s look at each of these three categories in more detail.
Major currency pairs comprise some of the world’s biggest economies: the Euro, Pound, US dollar, Japanese yen, New Zealand dollar, Australian dollar, Canadian dollar, and Swiss franc.
All major currency pairs are listed with the US dollar because the US dollar is seen as the world’s primary reserve currency. The US dollar can be either the base currency or the quote currency; for example, in USD/JPY, it’s the base currency. While in EUR/USD, it’s the quoted currency.
Minor currency pairs, also known as cross currency pairs, still include any major currency pairs; however, they don’t include the US dollar. For example, EUR/GBP or GBP/CAD.
Even though these currency pairs are still popular among many traders, they see less liquidity than the major currency pairs since they don’t include the US dollar.
Exotic currency pairs are some of the least traded currency pairs. These consist of one major currency paired with a currency from an emerging economy. For example, GBP/SGD (Great British pound against the Singapore dollar) or USD/ZAR (US dollar against the South African rand).
For the most part, traders will end up trading the major currency pairs rather than the minors or exotics, mainly due to the high liquidity the major currency pairs offer.
One of the primary purposes base and quote currencies are used for is in forex trading, where traders try to profit by speculating on the price movements of currency pairs, where one currency is traded against another.
When a trader looks at a currency pair such as EUR/USD, for example, they will predict that the value of the euro will increase against the US dollar or decrease, and depending on their analysis, they could either open a long (buy) or short (sell) position.
If they believe the euro's value will increase, they could open a long (buy) position by buying the euro and selling it at a later stage at a higher price with the hopes of making a profit.
If they believe the value will decrease, the opposite is true, where they could sell the euro and buy it back at a later stage at a lower price with the hopes of making a profit.
Another way in which base and quote currencies are used is with companies doing business internationally.
A company can watch the exchange rate of their local currency against another country’s currency, where business is conducted to calculate how much they’ll need to charge for their products or services. Or pay for certain products or services by using another currency.
In the world of forex trading, many factors could affect the price movement of base and quoted currencies. Below, you’ll find some factors that could influence the price movements of base and quote currencies.
Various geopolitical events and a state’s economic stability can create volatility in the forex market. Diplomatic events, conflicts, presidential elections, and trade agreements can lead to sudden and sharp currency fluctuations.
Macroeconomic factors affect the exchange rate of base currencies as well as quote currencies. Various economic indicators, such as inflation rates, employment data, GDP growth, and the interest rate of a country, can significantly impact a currency pair's value.
Traders closely monitoring these factors could make informed decisions and predict potential currency movements.
Central banks can play a crucial role in shaping the value of their respective currencies. Decisions about monetary policies, quantitative easing measures, and interest rates can significantly impact the exchange rate of a currency.
Traders could follow central bank announcements and statements to try and make calculated decisions on the movement of various currencies.
As previously mentioned, currencies in the forex market are always traded in pairs, and you can’t have a base currency without a quote currency. With that said, there are some differences between the two.
The main difference is the base currency will always appear first and the quote currency second. When a trader buys the base currency, they simultaneously sell the quote currency. Whereas if they sell the base currency, they are simultaneously buying the quote currency.
The other difference is that a base currency’s value will always equal one, whereas the quote currency’s value can change due to the exchange rate of how much it will cost to buy one unit of the base currency.
The base currency and the quote currency play a crucial role in the currency pair being traded.
Do you always buy the base currency?
Yes, you buy the base currency whenever you open a long (buy) position in a forex currency pair. If you open a short (sell) position in a forex currency pair, you will sell the base currency.
What happens when the base currency is stronger than the quote currency?
The base currency always equals one, and the quoted currency will indicate how much is needed to buy one unit of the base currency.
Now, if the value of the base currency increases, the quote currency will be affected by indicating a lower amount needed to purchase one unit of base currency.
For example, if you were looking at EUR/USD trading at 1.2500, you’ll need 1.25 US dollars to buy one euro. Now, if it were to move towards 1.3500, the euro's value would increase, and the US dollar's value would decrease, meaning you’d need more US dollars to buy one euro.
Is USD always the base currency?
No, the US dollar can be the base currency or the quote currency, depending on the currency pair being traded. For example, in USD/JPY, the US dollar is the base currency, and the Japanese yen is the quote currency; however, in EUR/USD, the euro is the base currency, and the US dollar is the quote currency.
How do you read forex quotes?
The way to read forex quotes is by looking at the quote currency's price. For example, if you were looking at the currency pair AUD/USD, the US dollar is the quoted currency, and the price listed under this currency states how much US dollar is needed to buy one Australian dollar.
Why is it called a base currency?
It’s called a base currency because that is the first currency listed in a forex currency pair. It acts as the reference point within the currency pair to indicate how much money of the quoted currency is needed to buy one unit of the base currency.
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