Definition of Base Currency
Base currency is the currency that is used as a reference in Forex trading and is used to assess the value of other currencies. In a currency pair, the base currency is the first currency listed before the quote currency. Buying or selling transactions in Forex trading always involve the base currency as the main reference point. The use of base currency is very important in Forex trading because the exchange rate between two currencies depends greatly on their comparison. For example, the EUR/USD currency pair shows the exchange rate between the Euro (EUR) and the US Dollar (USD). In this case, Euro is the base currency and Dollar is the quote currency. The exchange rate listed describes how much quote currency is required to purchase one unit of the base currency.
The interaction between the base currency and the quote currency is very relevant in determining profits or losses for traders. When carrying out a buying or selling transaction, the profit obtained will be calculated based on the difference in value between the base currency and the quote currency. This price difference is called the “spread.” Traders will always buy or sell using the base currency as a benchmark for calculating profits or losses. Learning the concept of base currency is an essential first step for beginners who want to enter the world of Forex trading. Understanding how the base currency and quote currency interact can help traders make better decisions and reduce the risk of loss. When making transactions, traders must be aware of changes in the exchange rate between the base currency and the quote currency so as not to add risk to the positions that have been opened.
Base Currency Function
The main function of a base currency is to determine how the value of one currency is measured against another currency. In the Forex market, currency pairs are always traded in simple form, such as EUR/USD, where EUR is the base currency and USD is the quoted currency. Base currency has an important role in determining currency exchange rates because every transaction in the Forex market involves buying one currency and selling another currency. Therefore, the exchange rate of a currency pair is expressed in units of the base currency which is equivalent to one unit of the quoted currency. For example, if the EUR/USD pair has an exchange rate of 1.1000, it means that 1 Euro can be exchanged for 1.1000 US Dollars.
The reason why a base currency is needed in the Forex trading system is because it makes it easier for investors and market players to interpret and understand exchange rates quickly and efficiently. Base currency allows all market players to have a unified understanding of quoted prices and assists in the process of technical or fundamental analysis of exchange rate fluctuations. In addition, the base currency is also important because it makes it easier to compare between various currency pairs and allows traders to make decisions based on market conditions. In short, the function and role of the base currency is very crucial in determining currency exchange rates and maintaining stability in the Forex trading system. Base currency makes it easier for market players to interpret price information, analyze exchange rate changes objectively, and assist in making the right decisions. Therefore, it is important to understand the concept of base currency and the reason for its existence in the Forex trading system to increase understanding of global market mechanisms.
Types of Base Currency
In Forex trading, several major currencies are often used as base currencies because of their stability, liquidity and popularity. The United States Dollar (USD) is one of the most commonly encountered examples. The strength of the US economy and its important role in world trade makes the USD a top choice for many traders. Euro (EUR) is a type of base currency which is also quite popular in the foreign exchange market. The official currency used by European Union member countries, the Euro is the currency with the second largest value after the US Dollar. The strong economic and political integration factors in the European region make it an attractive base currency for many market players.
Pound Sterling (GBP) or British Pound is no less popular as a base currency. The GBP is a symbol of the economic strength of Britain, one of Europe’s advanced industrial countries that has a long history in international trade and global finance. High liquidity and the influence of the London financial market also influence the use of Pound Sterling as a base currency in Forex transactions. Apart from the three main currencies above, several other types of currency such as Japanese Yen (JPY), Canadian Dollar (CAD), Australian Dollar (AUD), and Swiss Franc (CHF) are also often used as base currencies. Even though their popularity is not as big as USD, EUR, or GBP, these currencies are an important choice in Forex trading because of the economic stability of their country of origin and market movements which are often linked to economic conditions or global political turmoil.
Example of a Forex Transaction with Base Currency
The first example is a Forex transaction with the EUR/USD currency pair. Suppose the current price of EUR/USD is 1.2000, meaning you will need 1.20 USD to buy 1 EUR. If you want to buy 10,000 EUR units, you will need to exchange an amount of 12,000 USD. Then, if the price of EUR/USD rises to 1.2500 and you want to sell back the EUR you have purchased, then you will exchange 10,000 EUR units for 12,500 USD, resulting in a profit of 500 USD.
The second example involves the GBP/JPY currency pair, where the British Pound (GBP) is the base currency and the Japanese Yen (JPY) is the quote currency. Let’s say the current price of GBP/JPY is 150.00 which means you have to pay 150 yen for every pound you buy. If you decide to buy 1000 GBP, you will exchange 150,000 JPY. After some time, the price of GBP/JPY increases to 155.00 and you want to sell back the 1000 GBP you bought, you will receive 155,000 JPY thereby making a profit of 5,000 JPY.
In conclusion, the base currency has an important role in Forex transactions because it is the base currency used to measure the exchange rate of the currency pair being traded. Profit or loss is calculated based on changes in value between the base currency and the quote currency. The examples above show how price and profit/loss calculations are carried out in Forex transactions using currency pairs such as EUR/USD and GBP/JPY, which helps further understanding of the use of base currencies in Forex trading.
