The forex market is the largest and most liquid market globally, with trillions of dollars being traded daily between various participants. To understand this market—also known as foreign exchange or currency trading—it’s essential to become familiar with the most commonly traded currencies. Below is a look at six major currencies, including their key traits and characteristics.
Key Points
- Forex is the world’s largest and most liquid financial market.
- The U.S. dollar is the most dominant currency, but the euro, Japanese yen, Australian dollar, Canadian dollar, and British pound are also actively traded.
- The U.S. dollar is often involved in popular currency pairs and serves as a global reserve currency, making it central to currency trading.
- The Japanese yen is the most traded Asian currency, partly because of its role in the carry trade.
1. The U.S. Dollar
The U.S. dollar, often referred to as the “greenback,” is the most widely traded currency globally. It is a part of all major currency pairs and serves as a global reserve currency, held by nearly all central banks and institutional investors.
Due to its broad acceptance, the U.S. dollar acts as the base or intermediary in many triangular currency trades. Additionally, some countries use the U.S. dollar as their official currency through a process called dollarization. In other nations, it functions as an unofficial alternative currency alongside the local currency.
The U.S. dollar also plays a significant role in exchange rate policies. Some countries choose to peg or fix their currency to the dollar’s value to stabilize their exchange rates. For example, China has historically pegged its yuan to the U.S. dollar, a strategy that has sparked debate among economists and policymakers. Many countries opt for this approach to maintain exchange rate stability rather than letting market forces determine the currency’s value.
Another key feature of the U.S. dollar is its role as the standard currency for pricing most global commodities, such as oil and precious metals. This means that the prices of these commodities are not only influenced by supply and demand factors but also by fluctuations in the dollar’s value. Movements in U.S. inflation and interest rates can have a significant impact on the dollar, which in turn affects commodity prices.
2. The Euro
The euro ranks as the second most traded currency globally, following the U.S. dollar. It became the official currency for many nations in the eurozone starting on January 1, 1999, with physical currency (coins and banknotes) introduced three years later.
Several countries in Europe and Africa have pegged their currencies to the euro, much like others do with the U.S. dollar, to ensure exchange rate stability. The euro is also the second-largest reserve currency in the world.
Because the euro is widely trusted and used, it adds liquidity to any currency pair it trades against, making it a frequent choice for forex traders. The euro is often traded based on the overall economic health of the eurozone and its member countries. Political events in the eurozone can lead to significant trading activity, particularly in nations like Italy, Greece, Spain, and Portugal, which saw sharp drops in local interest rates following the adoption of the euro.
The euro is considered one of the most politically influenced currencies in the global forex market.
3. The Japanese Yen
The Japanese yen is the most frequently traded currency in Asia and is often seen as a reflection of Japan’s export-focused and manufacturing economy. Its performance is closely linked to the health of Japan’s economy, and it is sometimes used as an indicator for the economic conditions in the broader Pan-Pacific region, including South Korea, Singapore, and Thailand, whose currencies are less frequently traded in global markets.
The yen plays a key role in the carry trade, a strategy that profits from interest rate differentials between currencies. Investors borrow yen at low interest rates and invest in higher-yielding currencies to earn a profit from the difference.
Due to the yen’s heavy involvement in the carry trade, it often faces downward pressure, making significant appreciation challenging. While its value is still influenced by traditional market forces, the yen’s relationship with global interest rates, particularly those of major currencies like the U.S. dollar and the euro, significantly affects its value.
4. The British Pound
The British pound, or pound sterling, ranks as the fourth most traded currency globally. Despite being a former member of the European Union, the U.K. chose not to adopt the euro, largely to retain control over its own interest rates and maintain the historic significance of the pound.
The pound is often considered a direct reflection of the United Kingdom’s economic health and political stability. Its high value relative to other currencies makes it a key benchmark and an important reserve currency in the forex market.
5. The Australian Dollar
Known as the “Aussie,” the Australian dollar is a major currency in the Asia-Pacific region. It is considered a leading commodity currency, meaning its value is influenced by fluctuations in the prices of Australia’s key exports, such as minerals and agricultural products.
The AUD-USD currency pair represents about 6.37% of global forex trading volume, surpassing the volume of trades between the U.S. dollar and both the Swiss franc and the Canadian dollar.
6. The Canadian Dollar
Often referred to as the “loonie,” the Canadian dollar is another commodity currency, frequently moving in tandem with commodity prices, particularly crude oil, precious metals, and other natural resources. Given Canada’s significant role as a commodities exporter, the loonie tends to respond to changes in commodity markets, especially crude oil prices.
Traders often use the Canadian dollar to speculate on movements in commodity prices or to hedge positions in the commodities markets.
The Bottom Line
Each currency has unique characteristics that influence its value and movements in the forex market. Understanding these factors is essential for anyone looking to navigate the forex market successfully. Major currencies such as the U.S. dollar, euro, yen, British pound, Australian dollar, and Canadian dollar are key currencies to monitor.
