A Currency Pair is the quotation of two different currencies, with the value of one currency being quoted against the other. Think of it as a price tag, but instead of showing how many dollars an apple costs, it shows how many units of one currency it takes to buy one unit of another. This constant dance of values happens in the massive, global Foreign Exchange Market (also known as Forex), where trillions of dollars are traded daily. For example, if you see EUR/USD = 1.10, it means one Euro is worth 1.10 US Dollars. Every international transaction, from a corporation buying materials overseas to a tourist buying a souvenir, involves exchanging one currency for another. Understanding these pairs is the first step into the world of foreign exchange and a crucial piece of the puzzle for any global investor.
Every currency pair has a simple, universal structure. Let's break it down using the most traded pair in the world: EUR/USD.
So, when you “buy” EUR/USD, you are buying Euros and selling US Dollars. When you “sell” EUR/USD, you are selling Euros and buying US Dollars. The price movement is often measured in pips, which is the smallest standard increment of change in a currency quote.
Not all currency pairs are created equal. They are typically grouped into three categories based on their trading volume and liquidity.
These are the heavyweights of the Forex market. They all involve the US Dollar on one side and are traded in enormous volumes, which means they typically have very tight spreads (the difference between the buy and sell price).
These pairs feature major world currencies, but don't include the US Dollar. They are still quite liquid but generally less so than the majors. Examples include EUR/GBP, EUR/JPY, and GBP/AUD.
Exotic pairs consist of one major currency paired with the currency of an emerging or smaller economy. Think USD/TRY (US Dollar vs. Turkish Lira) or EUR/PLN (Euro vs. Polish Zloty). These pairs are far less liquid, more volatile, and have wider spreads, making them significantly riskier and more suitable for experienced traders.
At first glance, trading currency pairs seems like the domain of short-term speculation, the very opposite of value investing. And while that's often true, a savvy value investor doesn't trade currencies—they understand them as a critical factor in their investments.
If you're a US-based investor buying shares in a German company like Siemens, you aren't just buying the company; you're also making a bet on the EUR/USD pair. Your investment is priced in Euros. If the Euro strengthens against the Dollar, your returns will be magnified when you convert them back. If it weakens, your returns will shrink. This is known as currency risk, and it's a fundamental part of international investing that cannot be ignored.
Currency fluctuations directly impact a company's bottom line. A U.S. company like Apple, which sells iPhones all over Europe, receives revenue in Euros. If the Euro strengthens, those Euros translate into more Dollars, boosting Apple's reported earnings. Conversely, a weak Euro hurts their top line. A deep fundamental analysis of any multinational company is incomplete without considering how currency swings affect its revenues, costs, and profits.
Value investors can use long-term economic concepts to gauge currency valuations. One famous idea is Purchasing Power Parity (PPP). It suggests that, over time, exchange rates should adjust so that a basket of identical goods (like a Big Mac) costs the same in any two countries. If a Big Mac is much cheaper in Japan than in the US after converting the price, it might suggest the Yen is “undervalued” relative to the Dollar. While not a timing tool, PPP offers a logical, value-based framework for thinking about whether a currency is fundamentally cheap or expensive, which is a useful backdrop for making long-term international investment decisions.