Did you know you can trade currency pairs without involving the US dollar? Step into the realm of “Cross Currency Pairs / Cross Pairs” and discover new opportunities in forex trading beyond the popular EUR/USD, GBP/USD, and USD/JPY pairs.
Forex trading is the speculation on currency prices for potential profits. Since forex trading is primarily exchanging one currency for another, currencies in the forex market are traded in pairs. The currency pair is a quotation for one currency against the other: known as quote currency and base currency.
Trading a currency pair means that you buy or sell the base currency against the quote currency. That’s how trading currency pairs basically works. Since there are numerous currency pairs traded daily, they are categorized as major and minor or cross currency pairs, according to the daily trading volume.
What are Cross Currency Pairs?
Cross currency pairs are the currency pair that does not involve the US dollar. The crosses have slightly wider spreads. Despite enjoying sufficiently liquid markets, they are not as liquid as major pairs. The cross pairs with higher trading volumes are the ones that include a major currency.
Some Examples of Cross Currency Pairs are:
- EUR/GBP: Euro against the British Pound
- EUR/JPY: Euro against the Japanese Yen
- GBP/JPY: British Pound against the Japanese Yen
- EUR/CHF: Euro against the Swiss Franc
- AUD/NZD: Australian Dollar against the New Zealand Dollar
- EUR/CAD: Euro against the Canadian Dollar
- AUD/JPY: Australian Dollar against the Japanese Yen
- GBP/AUD: British Pound against the Australian Dollar
- NZD/JPY: New Zealand Dollar against the Japanese Yen
- GBP/CHF: British Pound against the Swiss Franc
While forecasting the EUR/GBP can be difficult because the interlinking economies of the UK and Eurozone, EUR/JPY is way easier to forecast. It also enjoys larger trends than USD/JPY as both the US dollar and the Japanese Yen are both perceived as safe-haven currencies. This makes the EUR/JPY a more popular cross currency pair, same as the EUR/CHF pair.
There are also what is called by exotic currency pairs; pairs that include currencies of emerging markets. They are not as liquid as major pairs or crosses, and the spread is also much wider.
How Cross Currency Pairs Emerged?
By the end of World War II, most currencies were pegged and quoted against the US dollar as the U.S. economy was the strongest in the post-war era and its currency was fixed to gold back then. So, when individuals wanted to exchange a sum of money into a different currency, they were required first to convert that money into US dollars and then convert it into the desired currency, incurring extra costs and delays.
Cross currency pairs emerged to facilitate direct currency conversions without the need for intermediate conversion into U.S. dollars. With the growth of the forex market and global trading, cross currency transactions and pairs gained popularity. Since the end of the gold standard and the rise of global trading, cross currency pairs have become a common part of everyday financial transactions.
Read what’s happening with the US dollar and why do countries ditch USD in 2023?
Major crosses are currency pairs that are actively traded and exclude the U.S. Dollar. They consist of the following currency pairs listed in alphabetical order:
These pairs have dedicated Interbank market makers and brokers.
Minor crosses are less actively traded currency pairs that generally lack dedicated Interbank market makers or brokers. They include the following pairs:
Despite their lower trading activity, Minor Crosses are still popular among forex traders and offer significant trading opportunities due to their potential for prolonged trends.
Difference Between ‘Cross Currency Pairs’ and ‘Cross Pairs’?
The terms “Cross Currency Pairs” and “Cross Pairs” have distinct meanings in the context of financial trading:
|Cross Currency Pairs
|Cross currency pairs specifically refer
to currency pairs in the foreign exchange
(forex) market that do not include
the U.S. dollar (USD) as one of the currencies.
|“Cross pairs” is a more general term that
encompasses a broader range of
financial instruments beyond currencies.
|These pairs directly compare two different
currencies without involving the USD.
|These pairs include any trading pairs
or instruments that involve two different
assets from different markets, such as
stocks, commodities, or cryptocurrencies.
|For example, EUR/JPY (Euro vs. Japanese Yen)
or GBP/AUD (British Pound vs. Australian Dollar)
are cross currency pairs.
|For instance, if you compare the price of
gold traded in the New York market
to the price of gold traded in the London
market, it would be considered a cross pair.
Why Trade Cross Currency Pairs?
Trading cross currency pairs provide additional trading prospects as these currencies are not tied to the US dollar and may demonstrate distinct price movement patterns. Traders may choose cross currency pairs for the following reasons:
- Portfolio diversification: Engaging in cross currency pair trading allows traders to diversify their portfolios and mitigate risks.
- Increased trading opportunities: Cross currency pairs offer a wider selection of currency pairs for traders to explore profitable prospects.
- Narrower spreads: As non-USD pairs gain popularity, the spreads have tightened, resulting in lower costs for currency conversions.
- Heightened risk: Exotic cross-currency pairs, which involve fewer participants in the forex market, are considered the riskiest among cross currency trading.
- Higher volatility: Cross currency pairs can exhibit greater volatility compared to major currency pairs due to their lower trading volumes and liquidity.
- Increased costs: Trading cross currency pairs involves various expenses, including wider spreads, higher commissions, and greater margin requirements.
In conclusion, trading cross currency pairs offer more trading opportunities and diversification. However, traders should be aware of the higher volatility, risks, and costs associated with such trading.
How to Calculate Currency Cross Rates?
To determine the rates of cross currency pairs, it is necessary to take into account the exchange rates between the two currencies involved. The process entails utilizing the exchange rates of each currency in relation to a shared base currency.
Here are the steps involved in calculating cross currency rates:
1. Identify the base currency:
Choose a common base currency against which both currencies in the cross pair will be assessed. For instance, if you wish to calculate the rate for EUR/JPY, you might opt for USD as the base currency.
2. Acquire the exchange rates:
Obtain the exchange rates for each currency in relation to the base currency. These rates can be obtained from financial websites, banks, or currency exchange services. Let’s assume the following exchange rates:
- EUR/USD = 1.20
- USD/JPY = 110.00
3. Calculate the cross rate:
To determine the rate for the cross currency pair (EUR/JPY), multiply the exchange rates of the individual currencies with respect to the base currency. In this case, you would multiply EUR/USD by USD/JPY.
- Cross rate = EUR/USD * USD/JPY
- Cross rate = 1.20 * 110.00
- Cross rate = 132.00
Therefore, the rate for EUR/JPY would be 132.00.
It's worth noting that cross currency rates are frequently computed automatically by financial systems and are readily available through various financial platforms or trading terminals. Nevertheless, comprehending the underlying calculations can be beneficial for gaining insights into the dynamics of currency pairs.
Key Considerations When Trading Cross Currency Pairs:
When trading cross pairs, there are several key considerations to keep in mind. Here are some of the most important ones:
- Yield differential: One advantage of trading exotic cross currency pairs is that the yield differential is often in favor of the less stable currency.
- Increased trading opportunities: By trading cross pairs in conjunction with major currency pairs, you can substantially increase the number of available trading instruments at your disposal, thus providing you with more trading opportunities.
- Illiquidity: Illiquidity can work as a double-edged sword when trading cross pairs. While it can lead to quick price movements, it can also make it difficult to exit a position quickly.
- Caution entering trends: Volatility within a range can result in small losses before a trend emerges, so be cautious when entering a trend.
- Political and financial instability: Cross pairs have an added layer of risk because instead of evaluating the political and financial instability of one country vs the US dollar, you are now analyzing two other economies against each other. It is important to stay informed about the political and economic conditions within the countries of the currencies you are evaluating.
- Economic reports: Using economic data can provide an edge, as strong demand for one currency and weak demand for another can enhance the probability of a trend.
- Spreads: Spreads play a significant factor in profitable forex trading. Some pairs are more advantageous to trade than others, and drawing conclusions on tradability based on the size of the spread (large vs. small) is not useful. Converting the spread into a percentage of the daily range allows traders to see which pair is offering the best value in terms of its spread to daily pip potential.
- Profit and loss: Selling a cross pair can be riskier than buying because when you exit, your profit (or loss) may be in a different currency than your base currency.
- Country’s economic strength: Strong economic reports can increase demand for a currency, while weak reports may lower demand.
Traders should keep these principles in mind to trade cross pairs with caution and potentially profit from speculation based on economic reports.
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