What Is a Counter Currency?
The term counter currency refers to the reference or second currency in a currency pair. Counter and base currencies are part of the currency or foreign exchange (forex) market. A trader or investors can determine how much of the counter currency they need to sell in order to purchase one unit of the first or base currency. The counter currency is listed after the base currency in the pair when currency traders examine ISO currency codes.
- A counter currency is the second or reference currency in a currency pair.
- The counter currency follows the base currency in ISO currency code pairs.
- Major currencies are more likely to be the base currency in a pair, especially when trading exotic currencies.
- Traders determine how many units of a counter currency they need to sell in order to purchase a single unit of the first or base currency.
- In order to determine how many units of the counter currency you need to sell, multiply the total number of units in the base currency by the exchange rate.
How Counter Currencies Work
The currency or forex market is one of the largest and most liquid markets in the world. Investors trade trillions of dollars worth of currencies in this market each day. It consists of an electronic network that consists of banks, brokers, traders, and institutions, rather than a centralized location like a stock exchange.
Currencies are listed in pairs on the forex market. This combination is called a currency pair. The first currency is called the base or transaction currency while the second one is the counter or quote currency. In the forex market, traders determine how much of the counter currency is required to buy one unit of the first or base currency. If you look up a currency pair using ISO currency codes, the counter currency is the one that follows the base currency.
Traders and investors should understand how currency pairs are structured in order to understand forex trading. The first or base currency is equivalent to one monetary unit, such as one dollar or one euro. Buying one euro in a EUR/USD currency pair means they receive a single euro by selling a certain number of U.S. dollars. In this example, the euro is the base currency while the dollar is the counter currency.
When an investor buys or goes long on a currency pair, they sell the counter currency but if they short a currency pair, they buy the counter currency.
Currency pairs—both base and counter currencies—are affected by a number of different factors. Some of these include economic activity, the monetary and fiscal policy enacted by central banks, and interest rates.
Major currencies, such as the euro and U.S. dollar, are more likely to be the base currency rather than the counter currency in a currency pair, especially when it comes to trades in exotic currencies. The most commonly traded currency pairs on the market in 2021 were:
As noted above, the first currency in these pairings is the base currency while the second one (after the slash) is the counter currency. In the GBP/USD pairing, the pound is the base currency or the one that is being purchased while the dollar is the counter currency. This is the one that is being sold.
Example of a Counter Currency
Let's assume a trader wants to purchase £400 using U.S. dollars. This would involve a trade using the GBP/USD currency pair. In order to execute the trade, they need to figure out how many USD (the counter currency) they need to sell in order to get £400.
The exchange rate for the pair at the end of the trading day on June 3, 2021, was 1.4103. This means it cost the trader $1.4103 to purchase £1. To complete the transaction on that day, the trader had to sell 564.12 units of the counter currency in order to get 400 units of the base currency or $564.12 for £400 (400 x 1.4103).