How exchange rates and currency pairs work
Understand what an exchange rate means, how currency pairs are written and why buying and selling prices differ.
What an exchange rate tells you
An exchange rate is the price of one currency in another currency. If 1 US dollar equals 1.70 manat, you need 1.70 manat to buy one dollar. Turned around, 1 manat buys about 0.59 dollars.
Currency pairs
In forex, currencies are always quoted in pairs. Each currency has a three-letter code. USD is the US dollar, EUR is the euro, GBP is the British pound, JPY is the Japanese yen and AZN is the Azerbaijani manat.
A quote such as EUR/USD 1.10 means one euro costs 1.10 dollars. The first currency is called the base currency. The second is the quote currency. The number tells you how much of the second currency you need to buy one unit of the first.
If EUR/USD rises from 1.10 to 1.15, the euro has become stronger against the dollar. If it falls to 1.05, the euro has become weaker.
The most traded pairs, called majors, all include the US dollar. Examples are EUR/USD, USD/JPY and GBP/USD.
Buying and selling prices
Look at any exchange office or banking app and you will see two prices. One is the price at which they buy a currency from you. The other is the price at which they sell it to you. The selling price is always higher.
The difference is called the spread. It is how banks and exchange offices make money. A smaller spread is better for you. Before changing a large amount, it is worth comparing a few banks.
Strong and weak currencies
When a currency becomes "stronger", it buys more of other currencies. Imports and foreign travel become cheaper for its people. Exporters may find it harder to sell abroad, because their goods become more expensive for foreigners.
When a currency becomes "weaker", the opposite happens. Imported goods become more expensive at home, which can push up inflation.
Pips
Online traders often talk about "pips". A pip is a very small unit of price movement, usually the fourth decimal place. If EUR/USD moves from 1.1000 to 1.1001, it moved one pip. Such tiny movements matter in trading mostly because traders use leverage, which we explain later in this section.
Key takeaways
- An exchange rate is the price of one currency in another.
- Currencies are quoted in pairs, such as EUR/USD.
- The first currency is the base and the second is the quote.
- Banks buy and sell currency at different prices. The difference is the spread.
- A stronger currency makes imports and travel cheaper.
- A weaker currency makes imported goods more expensive.
- A pip is a very small unit of price change used by traders.
Educational content only, not investment advice. Markets carry risk: only invest money you can afford to lose.