In every forex pair, there will be two different currencies, base and quote currency.
What is a ‘base currency’?
In a currency pair (AAA/BBB), you will determine one of them to be your base currency. This means all the conversions and calculations that you do will be relative to this currency. The other currency in the pair is called the ‘quote currency’.
Any exchange rate value will return the amount of quote currency needed to exchange for one unit of the base currency. For example, if you are looking at the USDEUR pair and want to set USD as a base currency, the exchange will return the amount of EUR needed to get 1USD. Most of the time, the currency you buy will be set as the base currency.
How to use ‘base currency’?
Many readers may wonder, ‘how will the ability to differentiate base currency from quote currency help me become a better and more effective trader?”
Having a strong foundation in these trading-specific terminology eliminates the risk of making silly mistakes when trading. One common mistake is when a trader changes between different currencies without knowing. This could slow down the process and cause confusion – you might miss a trading opportunity when figuring out where you went wrong!
With different currency pairs that have similar exchange rates – you might think you are profiting or losing but in fact; you’ve just mixed it up with another pair. It is good to establish a ‘base currency’ so that you can easily keep track of the progress of your trades to avoid this problem. This can be detrimental to your capital in a situation where you believe that your trade is profiting when you have just chosen the wrong currency, and in fact, you are currently losing and should cut your losses.
Furthermore, trading forex is a simultaneous process. This means you will buy and sell currencies at the same time. You need to establish a ‘base currency’ and then buy the pair if you believe it’s going to gain value and sell it if it’s going to drop in value.
Conclusion
Although it appears to be a simple concept, the understanding of base currency is something that all successful traders have. It will eradicate the risk of mistakes and make the trading process smoother. This will allow the trader to capitalize on all trading opportunities when they arise and have the confidence to make trades without having to double-check the contents of their trades every time.
