The vast majority of trading volume takes place in the major currency pairs: EUR/USD, USD/JPY, GBP/USD, and USD/CHF. These currency pairs account for about two-thirds of daily trading volume in the market and are the most watched barometers of the overall forex market. When you hear about the dollar rising or falling, it’s usually referring to the dollar against these other currencies.

Even though these four pairs are routinely grouped together as the major currency pairs, each currency pair represents an individual economic and political relationship. We will look at the fundamental drivers of each currency pair to see what moves them. We will also look at the market's quoting conventions and what they mean for margin-based trading.

Although it’s important to understand why a currency rate moves, I think it’s also essential to have an understanding of how different pairs’ rates move. Most currency trading is very short-term in nature, typically from a few minutes to a few days. This makes understanding a currency pair’s price action (how a currency pair‘s price moves in the very short term) a key component of any trading strategy. 

The Big Dollar: EUR/USD

EUR/USD is by far the most actively traded currency pair in the global forex market. Everyone and his brother, sister, and cousin trades EUR/USD. This will come as no surprise to anyone who has traded in the forex market, because if you have, more likely than not you traded EUR/USD at some point.

 The same goes for the big banks. Every major trading desk has at least one and probably several, EUR/USD traders. This is in contrast to less liquid currency pairs such as GBP/USD or AUD/USD, for which trading desks may not have a dedicated trader. All those EUR/USD traders add up to vast amounts of market interest, which increases overall trading liquidity.

Trading fundamentals of EUR/USD

EUR/USD is the currency pair that pits the U.S dollar against the single currency of the Eurozone, the euro. The Eurozone refers to a grouping of countries in the European Union (EU) that in 1999 retired their own national currencies and adopted a unified single currency. In one fell swoop, at midnight on January 1, 1999, the Deutsche mark, Italian lira, French franc, and nine other European currencies disappeared and the euro came into being.

The move to a single currency was the culmination of financial unification efforts by the founding members of the European Union. In adopting the single currency, the nations agreed to abide by fiscal policy constraints that limited the ratio of national budget deficits to gross domestic product (GDP), among other requirements. The nations also delegated monetary policy (setting interest rates) to the newly founded European Central Bank (ECB).

As of this printing, the countries that use the euro are: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Slovenia, and Spain. All together, the Eurozone constitutes a regional economic bloc roughly equal to the United States in both population and total GDP.

Trading EUR/USD by the numbers

Standard market convention is to quote EUR/USD in terms of the number of USD per EUR. For example, a EUR/USD rate of 1.3000 means that it takes $1.30

to buy €l.

EUR/USD trades inversely to the overall value of the USD, which means when EUR/USD goes up; the euro is getting stronger and the dollar weaker. When EUR/USD goes down, the euro is getting weaker and the dollar stronger. If you believed the U.S. dollar was going to move higher, you’d be looking to sell EUR/USD. If you thought the dollar was going to weaken, you'd be looking to buy EUR/USD.

EUR/USD has the euro as the base currency and the U.S. dollar as the secondary or counter currency. That means

• EUR/USD is traded in amounts denominated in euros. In online currency trading platforms, standard lot sizes are €100,000, and mini lot sizes are € 10,000.
• The pip value, or minimum price fluctuation, is denominated in USD.
• Profit and loss accrue in USD. For one standard lot position size, each pip is worth $10; for one mini lot position size, each pip is worth $1.
• Margin calculations in online trading platforms are typically based in USD. At a EUR/USD rate of 1.3000, to trade a one-lot position worth €l00, 000, it’ll take $1,300 in available margin (based on 100:1 leverage). That calculation will change over time, of course, based on the level of the EUR/USD exchange rate. A higher EUR/USD rate will require more USD in available margin collateral, and a lower EUR/USD rate will need less USD in margin.

Swimming in deep liquidity

Liquidity in EUR/USD is unmatched by other major currency pairs. This is most evident in the narrower trading spreads regularly available in EUR/USD.

Normal market spreads are typically around 2 to 3 pips versus 3 to 5 pips in other major currency pairs.

In terms of concrete numbers, EUR/USD accounted for 28 percent of global daily trading volume, according to the 2004 Bank for International Settlements (BIS) survey of the foreign exchange markets. That’s more than one and a half times the volume of the next most liquid currency pair (USD/JPY).

Liquidity in EUR/USD is based on a variety of fundamental sources, such as

• Global trade and asset allocation: The Eurozone constitutes the second largest economic bloc after the United States. Not only does this create tremendous commercial trade flows, but it also makes Eurozone financiall markets, and the euro, the destination for massive amounts of international investment flows. In April 2007, overall European stock-market valuations surpassed the value of U.S. equity markets for the first time ever.
• Central bank credibility: The ECB has established itself in the eyes of global investors as an effective institution in fighting inflation and maintaining currency stability.
• Enhanced status as a reserve currency: Central banks around the world hold foreign currency reserves to support their own currencies and improve market stability. The euro is increasing in importance as an alternative global reserve currency to the U.S. dollar.

The euro also serves as the primary foil to the U.S. dollar when it comes to speculating on the overall direction of the U.S dollar in response to U.S news or economic data. If weak U.S. economic data is reported, traders are typically going to sell the dollar, which begs the question, “Against what?" The euro is the first choice for many, simply because it's there. It also helps that it’s the most liquid alternative, allowing for easy entry and exit. ,

This is not to say that EUR/USD only reacts to U.S. economic data or news. On the contrary, Eurozone news and data can move EUR/USD as much as U.S data moves the pair. But the overall tendency still favors U.S data and news as the driving force of short-term price movements.

This situation is partly a function of geography and daily trading rhythms, because European data is released about four to eight hours before U.S economic reports are typically issued. On any given day, traders will respond to European news and data and adjust prices accordingly for several hours until U.S. data is released.

Watching the data reports

Country-specific economic reports, such as Dutch retail sales or Italian industrial production, are increasingly disregarded by the forex market in favor of Eurozone aggregate economic data. However, German and French national economic reports can still register with markets as they represent the two larges Eurozone economies. Here’s a list of the major European data reports and events to keep an eye on:

• European Central Bank (ECB) interest rate decisions and press conferences after ECB Central Council meetings: This is when the ECB president explains the ECB’s thinking and offers guidance on the future course of interest rates.
• Speeches by ECB officials and individual European finance ministers.
• EU-harmonized Consumer Price Index (CPI), as well as national CPI and Producer Price Index (PPI) reports
• EU Commission economic sector confidence indicators.
• Consumer and investor sentiment surveys separately issued by three private economic research firms known by their acronyms: Ifo, ZEW and GfK.
• Industrial production
• Retail sales
• Unemployment rate