Trading with cross currency pairs in Forex: A complete trading guide
Most new traders find their way to the market through major currency pairs like EUR/USD, GBP/USD or in the case of reversals USD/JPY. However, there are entirely new possibilities available to traders without reference to the USD, and those are called cross currency pairs. Cross currency pairs are pairs that will not involve USD at all such as EUR/GBP, EUR/JPY or GBP/JPY.
Understanding and mastering cross currency pair trading can provide new profit opportunities especially when USD pairs are going nowhere, or a specific region is creating economic events to trade Non-USD currencies from. Most cross currency pairs operate with different latent volatility patterns, correlation structures, latent currency behavior, and market cycle positions in response to global economic events.
Cross Currency Pair Basics
Cross currency pairs, sometimes referred to as 'crosses', are currency pairs with no USD anywhere in the currency pair. Major currency pairs use USD either as the base currency or quote currency. Cross currency pairs consist of direct exchanges between 2 other currencies, which creates a different market dynamics that every trader should understand.
The most traded active cross currency pairs are EUR/GBP (Euro/British Pound) EUR/JPY (Euro/Japanese Yen), and GBP/JPY (Pound/Yen). They are good examples as they are relationships between some of the most economically important regions and currencies in the world, and, as such, they tend to be liquid enough for retail traders to trade and, still have different characteristics than their USD equivalent.
Key Differences from Major Pairs
Cross currency pairs are mostly volatile when compared to major USD pairs due to their lack of liquidity and the complex price formation process. In trading a cross such as EUR/GBP, you are factoring in not only Euro and Pound fundamentals, but also their relationship to the dollar and their relationship to global markets. This layering creates some complexities that lend itself to more abrupt price differentiation.
In general, liquidity will be lower in cross currency pairs than major pairs. Cross currency pairs may have wider spreads depending on market conditions and greater slippage in super volatile market conditions. The most popular crosses - for example, EUR/GBP, EUR/JPY, GBP/JPY will maintain their liquidity during major trading sessions to accommodate most retail trading approaches.
Guidelines for Selecting Cross Currency Pairs
Selecting cross currency pairs is critical for your trade success. Some crosses are better than others and knowing the major criteria for the selection of pairs can mean the difference between successful trading and disappointing losses. The selection process should primarily consider liquidity, volatility, trading sessions, and fundamental drivers.
The most important factor to consider when choosing cross currency pairs is liquidity. High liquidity leads to tighter spreads, better order execution, and less risk for slippage. The most liquid cross currency pairs are EUR/GBP, EUR/JPY, GBP/JPY, AUD/JPY, EUR/AUD, and GBP/AUD.
Trading Strategies for Cross Currency Pairs
Trading cross currency pairs requires specific strategies that are mindful to the particulars of cross currency pairs. Currency crosses do not necessarily follow the same trends as USD pairs. They may be acting differently by way of support and resistance, and appear to have different technical indicator patterns. Below are successful trading strategies that were created for cross currency trading.
Cross currency pairs often experience strong, sustained trends due to their fundamental drivers and lower liquidity. The goal is to correctly identify the trend direction early and ride the trend as it builds momentum while managing risk.
Conclusion
Cross currency pair trading represent one the most advanced and potentially lucrative areas of the forex markets. Through the complete review of this e-book, we have explored the key concepts, strategies and techniques to achieve success in these highly complex and opportunity-rich markets.
The transition from the rudimentary aspects of cross currency principles to more sophisticated portfolio approaches requires persistence, practice, and ongoing education. We have examined the core characteristics that distinguish crosses—their heightened volatility, disparate levels of liquidity, and convoluted fundamentals that result in opportunities and complications for participants at all skill levels.
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