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.
Cross currency pairs are actual currency pairs that indicate a direct exchange between two non-USD currencies. There are also indirect currency pairs, which is a trade that is applied to one outside the native currency pair. An Example was a recent article based on USD/JPY, and the use of it in a specific trade with the JPY (.68). The graph shows the dollar price agreement which was used for long or short.
Cross currency pairs allow traders to explore this spectrum of possibility with different currencies and their different trading. While the USD is due to its international relevance and as the world's only reserve currency, cross currency pairs allow traders to position themselves regarding other major economies without US 'noise' or market sentiment.
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.
This ultimate beginners to advanced guide will permit you the opportunity to walk though all aspects of cross currency trading. We will explains how to obtain the best trading pairs, build solid trading strategies, manage your risk, and how develop and implement a systematic view of cross currency trading.
No matter whether you are a new trader who would like to expand into the other pairs from the majors or an intermediate trader who would like to improve your cross currency strategies this guide will provide you with some fundamentals as to how to trade cross currency pairs.
When you finish this article, you will have an understanding of the make up of what all cross currency pairs will consist. How to identify the best trade opportunities, and how to implement risk management strategies. These that help you navigate the sometimes difficult, and at times very profitable, cross currency trading markets.
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.
In order to bring together the notions of currency pairs, pricing in currency pairs, USD transaction and cross currency pairs: One could think of the USD as a 'universal campus currency' in an analogy.
Thus, in most transactions, traders exchange their local currency for USD, and then exchange UD for their desired currency. Cross currency pairs are like when two student exchange two tokens on campus , without using the universal campus currency first!
These two student tokens create a peer to peer, direct relationship and the dynamics and reactions to specific types of regional economic information will thus be even more pronounced because the cross currency price will include that local information, therefore impacting the dynamics of the currencies even more.
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.
Increased risk is balanced with some criteria. The major advantage of cross currency pairs is to provide pure exposure to specific bilateral economic relationships. When trading the EUR/GBP cross, you not only focus on the fundamentals from the Eurozone economy and the UK economy, you have separated out the US dollar influence. If there are periods of volatility around the dollar, or a number of regional economic events create a strong directional bias, this can be very valuable.
Cross currency pairs also offer great diversification benefits. A trader is able to diversify their risk over separate currency relationships and when USD pairs are flying in ranges, they may find opportunities. Other cross currency pairs often clearly demonstrate a very strong trending behavior, and showing a technical pattern that could be easier to trade than a difficult USD pair that is simply choppy in price action.
The disadvantages, meanwhile, are that they can carry wider spreads, higher volatility which can get a trader stopped early, and fundamentally can be harder to assess what determines the rate. A trader must remain aware of multiple central banks, economic calendars, and regional news developments at the same time, which adds complexity. Some of these cross rates are very synthetic (i.e quality based on USD pairs) which can open small arbitrage opportunities that can disappear quickly by sophisticated algorithms.
Understanding these basic elements of structure creates a foundation to be good at cross currency trading. The most important element is to remember that cross currency pairs provide unique opportunities, but they do require different and adjusted position sizing, risk management, and analytical approaches as compared to most major larger USD pairs.
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.
Liquidity Priority:
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.
Above-average liquidity develops when there are active participants in the market: institutional traders, banks and retail traders which generates deep order books. It is the depth of the order book which provides room and flexibility in execution.
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