Trading the EUR/USD Currency Pair – A Beginner’s Guide
The Euro/U.S. dollar currency pair denotes the exchange rate between the euro and the U.S. dollar and expresses it as the number of dollars needed to buy one euro.
For example, if the EUR/USD exchange rate is 1.15000, it means you need $1.15 to buy one euro. In this pair, the euro is the base currency, and the U.S. dollar is the quote currency.
With an impressive daily turnover of about $1.173 trillion, the EUR/USD is the most liquid currency pair in the world. The total daily turnover in the forex market is approximately $5.1 trillion, which means the EUR/USD represents 23 percent of this colossal amount.
Euros and Dollars
History of the Euro Currency
The euro is a much younger currency than the U.S. dollar. The euro was introduced in 1999, although it was only used as a virtual accounting currency until January 1, 2002, when the first euro notes and coins came into circulation.
The euro soon became the official currency of the European Union and replaced many of the currencies of the different members. Today, it is the common currency of 19 of the 28 countries in the European Union.
The United States Dollar
Contrary to the euro, which has been in circulation for less than 20 years, the U.S. dollar has been the United States’ standard monetary unit for more than 200 years.
The U.S. dollar is the most traded currency on the planet. It is also the world’s number one reserve currency.
How the EUR/USD is Traded
Although there are other ways to trade this currency pair, we’ll focus only on how it’s done with retail forex trading.
EUR/USD Lot Size
A standard lot in forex is 100,000 of the particular currency pair. However, most retail forex brokers offer lot sizes as small as 0.01 lots, which is 1000 of the particular currency pair. This is called a micro lot. Some trading platforms denote this as a 1K lot size. Others refer to a 1K lot as one unit.
For a really small investor, a 1K lot sounds like a really big trade size. After all, how would someone with a $500 account be able to open a 1000 euro position? Well, the great thing about trading forex is that retail brokers allow you to trade with leverage.
The leverage offered by retail forex brokers generally vary between 1:100 and 1:1000. Some brokers offer ridiculously high leverage of 1:2000, 1:3000, and even 1:5000. Of course, some countries regulate the amount of leverage you can use as a retail forex trader, like the United States which allows a maximum leverage of 1:50.
Let’s use 1:100 leverage as an example. If you have a $500 account and you want to open a 1K trade on the EUR/USD, you will need less than $11.00 to open this position. This is based on an exchange rate of 1.06000 dollars per 1 euro. Without using leverage, this would not be possible because a 1K lot of the EUR/USD is worth $1060.
Make sure you use the right lot size. Overleveraging is dangerous!
Pip Value of the EUR/USD
To establish the pip value of the EUR/USD, we first need to consider what a pip is. If the EUR/USD is trading at 1.00010 and the exchange rate moves to 1.00020, it has moved one pip higher. The fourth digit after the decimal point is called a pip.
To calculate the pip value of the EUR/USD, we’ll use a 1K lot as an example. On the EUR/USD, one pip is 0.0001, or 1/10000 of one U.S. dollar. Multiply this by 1000 and you get $0.10. This is the pip value of a micro lot (1k lot) of the EUR/USD.
Profit and Loss Calculation
Here at FXLeaders, we go the extra mile to offer traders the best forex signals possible. In 2016 alone, we bagged a phenomenal 4,907 pips! A substantial amount of these gains came from our EUR/USD signals.
Let’s calculate how much money you’d make if you traded a EUR/USD signal with 12 micro lots and hit a profit target of 276 pips. 12 micro lots, is 12,000 of the EUR/USD currency pair. If we multiply this by $0.0276, which is 276 pips, we get $331.20. (12,000X$0.0276=$331.20).
If that sounds a little bit complicated, you can just multiply the pip value of a 1K lot, which is $0.10, by the number of micro lots traded, and multiply this number by the number of pips you made: $0.10 pip value X 12 micro lots X 276 pips = $331.20.
Instruments Correlated to the EUR/USD
Of the major currencies, the Swiss franc bears the highest correlation to the euro. Hence, the EUR/USD and the USD/CHF currency pairs are inversely correlated to a great degree. The one-year correlation between the EUR/USD and the USD/CHF is -0.95, which means they are almost perfectly inversely correlated, so to speak.
Generally speaking, the other European currencies are also highly correlated to the euro, for instance, the Hungarian forint (HUF).
The GBP/USD is also correlated to the EUR/USD and these two pairs have a one-year correlation of 0.77, which is considered a relatively high correlation.
When we examine currency correlations, it is important to understand that short-term and long-term correlations between the same two pairs can be remarkably different. For example, the EUR/GBP and EUR/USD one-hour correlation is currently 0.96, which means that these two pairs basically moved in tandem over the last hour.
However, their one-year correlation is -0.44, which means they were moderately inversely correlated over the last year. Something else to keep in mind is that correlations are not set in stone, and can change at any time, even if it’s just a short-term deviation.
Correlated Equity Indices
Global equity indices are generally inversely correlated to the EUR/USD, especially the European indices. For example, the Dax (German 30) and the EUR/USD have a one-year correlation of -0.78, which is considered a strong inverse correlation.
Major Economic Events that Impact the EUR/USD
Of the many economic events that influence the EUR/USD, there are a few that can cause substantial volatility in this exchange rate:
1. Monetary Policy – Actions and Comments by Central Banks
Monetary policy is certainly one of the most important drivers of the EUR/USD. The Federal Reserve of the United States and the European Central Bank are in charge of their countries’ monetary policies.
The ECB (European Central Bank)
When the FED and the ECB comment or take action in regards to interest rates, quantitative easing, inflation, and economic growth forecasts, it often causes violent moves in the EUR/USD exchange rate.
2. Economic Indicators
Economic indicators are used to analyze how well a country’s economy is performing, and to predict future economic growth. There are three main categories of economic indicators: leading, lagging, and coincident indicators.
Indicators like GDP numbers (gross domestic product), CPI numbers (consumer price index), interest rate decisions, the unemployment rate, wage growth, industrial production, and retail sales numbers, are regularly released in both the U.S. and Europe.
Although these aren’t the only important economic indicators, they have great potential to move the EUR/USD, especially interest rate decisions, GDP and CPI numbers, and labor market data (like the U.S. nonfarm payrolls numbers, unemployment rate, etc.).
Of the European countries that use the euro, Germany, France, and Italy have the largest economies. Germany is the biggest, with France right behind it, and Italy taking third place. Therefore, when economic indicators of individual European countries are released, we can turn our focus to these three countries, especially to Germany.
Although economic news out of the Eurozone can move the EUR/USD exchange rate considerably, the most market-moving economic news releases typically emanate from the United States.
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