A comparison of base currency vs quote currency
In this article, we will be exploring what is the base currency vs the quote currency in a currency pairing. The importance of these words is greatest in foreign exchange. To begin, as we know, whenever one trades in currencies, they always have to trade in some kind of pairing. The first currency in the pair will be the base currency, and the second of these will be the quote currency. Usually, they will find these two currencies in their abbreviations, right next to each other. So, if we were to take an example of GBP/USD, the base currency would be GBP (Great British Pound), and the quote currency would be USD (US dollar). So this is how to differentiate a base vs quote currency. A forex investor could, of course, flip this GBP/USD. So now GBP would be the base currency, and the quote currency would be USD.
This is just one of many trading pairs. Other major currency pairs are: USD/CHF, USD/JPY, EUR/USD, USD/CAD, and AUD/USD. Seeing as USD is the most important and one of the most stable currencies in the world, it is very popular in currency pairs. Some minor currency pairs are: EUR/CHF, GBP/EUR, and GBP/CHF. Currency pairs using more obscure currencies would be exotic pairs.
So when a possible investor is investigating these trading pairs, they find out about the exchange rate. That would be the equivalent value of the base currency converted into the quote currency. They will sell one currency, the base, and buy up the quote currency. To further explain how it works, it could be that GBP/USD = 1.31. This means that one British pound is the equivalent of 1.31 US dollars. This would scale up with greater investments, so £100 would be equivalent to $131. The reversal of this would be USD/GBP = 0.76, so $1 is equal to £0.76. Usually, because the fluctuations in the rates can be quite small, forex investors will look at these to small digits. Specifically, they would look at ‘pips’, which is the currency exchange rate value to the 4th digit.
Choosing a quote and base currency for investors
It matters which is the base and which is the quote currency, depending on which currency is likely to devalue and which is likely to appreciate.
If an investor expects the price of a quote currency to rise in relation to its current exchange rate, he can take advantage of the situation. He can buy up the quote currency and sell it later. Thus he/she ends up with a greater amount of the base currency and thereby profits. The investor can also trade in for the quote currency temporarily to avoid any devaluations of the base currency.
An investor will keep in mind several factors when considering the currency pair they desire. When choosing a base currency, there are a few things to keep in mind. For one, the relationship between the base and quote currency is governed by the interest rate of each of them. The overall relative interest rate between the currencies determines which is more likely to appreciate in value relative to the other. This would be the interest rate parity between two different currencies.
They will also have to keep in mind the economies of other countries, and keep a close eye on political events to see how the currency of a particular country might change. Certain commodities can also have a significant impact on the exchange rate of a currency. For example, sudden changes in oil prices can have significant effects on the value of a currency, as many countries are heavily reliant on oil.
Businesses choice in currency pairs
The importance of quote currency vs base currency is also great for businesses, not only individual foreign exchange investors. A business in one country may be trying to set up a location in another country. For example, a French business is trying to expand its operations to the US. They will, at some point, need to take a look at the EUR/USD currency pair. When finding the values of the parts they need to set up this new location (building, supplies, etc.), it will get a certain value. However, since exchange rates change all the time, they will need to evaluate if the future exchange rate will be the same. This risk assessment can be of enormous value. In fact, if a business plans carefully, they can end up saving money by waiting until the value is more beneficial to them than it currently is.
Hopefully, this article has clarified the difference between base and quote currencies and made clarifications on currency pairs in general.