Lesson 4 – EUR/USD pair

The EUR/USD currency pair stands for the Euro against the US dollar, which are the two major global currencies in the world economy. The USD represents the economy of the United States of America, while the EUR is the currency used in the European Union and EEA.  The currency pair indicates how many US dollars are needed to buy 1 euro. Since the EUR is the base currency in this pair, while the USD is the quote currency, trading the pair is often dubbed ‘trading the euro’.

Why is the EUR/USD pair important?

The EUR/USD pair is the most traded pair in the world, as it signifies the blend of two of the world’s biggest economies.  Various factors affect the value of the pair, such as economic, political, and social. Due to this, the interest rate differential between the ECB (European Central Bank) and Fed (Federal Reserve), which is the measure of difference in the interest rates of two different financial assets, affects the currency pair’s values when compared to one another.

If the Fed attempts to make the USD stronger by intervening in open market activities, the value of the pair may decline. Same goes if the European economy is in trouble, for example, the government debt crisis in Greece had negative effects on the currency pair as there was a massive euro selloff.

A brief history of the USD and EUR

The American dollar was based by value and appearance on the Spanish dollar.  The very first dollar coins were issued by the US Mint in the same year that it was founded (1792). After the adoption of the United States Constitution, the dollar became the official currency of the US. Initially, the currency’s value depended on precious metals, so when the Mint Act was passed, one dollar was defined as 24.056 grams of silver.

This was eventually suspended as more paper currency came into circulation. Since the 70s, the dollar has been the de facto fiat currency of the US. The dollar is the world’s primary reserve currency and is used as a sole currency in other countries aside from the United States. Currently, there are about $1.2 trillion dollars in circulation. 

The Euro was born much later. The currency originated in 1992 and was the result of the Maastricht Treaty. It is the official currency of 19 out of the 27 member states of the European Union, also known as the eurozone. It is the second largest and second-most traded currency in the foreign exchange market following the USD.

The currency was introduced as an accounting currency in financial markets in 1999 and became a physical currency in 2002. It then became the day-to-day operating currency of the original member states and within a year, fully replaced the former local currencies. 

The forex market was very different in the late 90s; at the time, the German Deutschmark and the US Dollars were the biggest currency pairs.  In the early 2000s, the Euro replaced other local currencies like the Italian Lira, Spanish Peseta, and the French Franc.

 

What affects the value of the EUR/USD pair?

The value of the EUR/USD pair can be heavily influenced by various factors, for example, the strength of either of the economies, their monetary policy, and global political events. The Fed makes aggressive attempts to stimulate the US economy, while in contrast, the ECB tends to focus on price stability. 

The difference in this has led to some interesting effects on the currency pair. For quite some time, the FED stimulus was what affected the price fluctuations of the pair. Another important event was the Eurozone sovereign debt crisis, which was when several member states faced a crippling amount of national debt.

Some major events that affected the EUR/USD pair were:

• 2008 – Fed cuts rates: Euro strengthened against the dollar

• 2016 – Donald Trump wins presidential election: Euro weakens against the dollar

• 2020 – ECB announces new stimulus package to fight the impact of COVID-19: Euro strengthens against the dollar

What is the best time for trading the EUR/USD?

Since the FX market is open 24 hours a day, 5 days a week, trading can take place technically at any point, with the exception of the 48 hours on the weekend.

Of course, some timings are better than others – it is best to trade the pair when the market is most active since that’s when there is significant movement and volatility. Currency pairs usually trade best when their stock market hours collide. For example, the EUR/USD is most active between 5 am and 2 pm GMT, specifically during the 2-3 hour overlap when both European and American markets are open and offer the most volume and volatility. Before those hours, price fluctuation is usually slowed down significantly.

The best period for trading the pair is when trading hours overlap between 12 pm GMT and 3 pm GMT, which is when markets in the US, London and Europe are open.