Even though the Dollar is the current king, you don’t have to trade it if you don’t want to. You can trade non-dollar pairs called currency cross pairs!
What is a Currency Cross Pair?
Back in the ancient days, if someone wanted to change currencies, they would first have to convert their currencies into U.S. dollars, and only then could they convert their dollars into the currency they desired. For example, if a person wanted to change their U.K. sterling into Japanese yen, they would first have to convert their sterling into U.S. dollars, and then convert these dollars into yen.
With the invention of currency crosses, individuals can now bypass the process of converting their currencies into US dollars and simply convert it directly into their desired currency.
Some examples of crosses include: GBP/JPY, EUR/JPY, EUR/CHF, and EUR/GBP.
Calculating Currency Cross Rates
Warning: This part is a little boring…unless you like numbers. It’s not difficult but it can be kind of dry.
The good news is that this section really isn’t necessary anymore since most broker platforms already calculate cross rates for you.
However, if you are the type that likes to know how everything works, then this section is for you! And besides, it’s always good to know how things work right? In this section, we will show you how to calculate the bid (buying price) and ask (selling price) of a currency cross.
Let’s say we want to find the bid/ask price for GBP/JPY. The first thing we would do is look at the bid/ask price for both GBP/USD and USD/JPY.
Why these 2 pairs?
Because both of them have the U.S. dollar as their common denominator.
These 2 pairs are called the “legs” of GBP/JPY because they are the U.S. dollar pairs associated with it.
Now let’s say we find the following bid/ask prices:
GBP/USD: 1.5630 (bid) / 1.5635 (ask)
USD/JPY: 89.38 (bid) / 89.43 (ask) To calculate the bid price for GBP/JPY, you simply multiply the bid prices for GBP/USD and USD/JPY.
If you got 139.70, good job! Your calculator is working properly, yipee!
To get the ask price for GBP/JPY, just multiply the ask prices for GBP/USD and USD/JPY and we get 139.82.
Easy as pie!
Why Trade Currency Crosses?
Over 80% of the transactions in the forex market involve the U.S. dollar.
This is because the U.S. dollar is the reserve currency in the world.
You may be asking yourself, “Why the U.S. dollar and not the sterling, or euro?”
Most agricultural and commodities such as oil are priced in U.S. dollars.
If a country needs to purchase oil or other agricultural goods, it would first have to change its currency into U.S. dollars before being able to buy the goods.
This is why many countries keep a reserve of U.S. dollars on hand. They can make purchases much faster with Greenbacks already in their pocket.
Countries such as China, Japan, and Australia are examples of heavy importers of oil, and as a result, they keep huge reserves of U.S. dollars in their central banks.
In fact, China has over 3 trillion U.S. dollars in its reserve stockpile!
So what does this all have to do with trading currency crosses? Well since most of the world is glued to the U.S. dollar, a majority of trading speculation will be based on one question:
“Is the U.S. dollar weak or strong today?”
This one question will affect many of the most liquid currency pairs:
The commodity pairs:
Notice that all of these pairs are tied to the U.S. dollar.
This doesn’t give a trader many options when most of their trading decisions are based on this one speculation.
You can see that by trading any of the 7 most popular currencies, you are basically taking either an anti-U.S. dollar or pro-U.S. dollar stance.
This one speculation affects these pairs in almost the same way across the board.
Conversely, in the stock market, traders have multiple companies to choose from and are not bound to one major speculation idea.
With stocks, you can see that even though the overall market was positive, there are still plenty of other trading opportunities. There isn’t just one kind of speculation that affects the entire basket of stocks.
Currency Crosses Provide More Trading Opportunities
Instead of just looking at the seven “major” dollar-based pairs, currency crosses provide more currency pairs for you to find profitable opportunities!
By trading currency crosses, you give yourself more options for trading opportunities because these currencies are not bound to the U.S. dollar, thus possibly having different price movement behaviors.
So while the majority of the markets will only trade on anti-U.S. dollar or pro-U.S. dollar sentiments, you can find new opportunities in currency crosses.
For example, all the dollar-based pairs might be trading sideways or in some uglier fashion where it would be smart to just SIT on the sidelines and WAIT for better trade setups
But if you knew to switch your charts to look at currency crosses, you might just find trading opportunities galore!
Be different! The majority of traders just trade the majors.
Now you can be part of the minority that trade currency crosses.
Currency Crosses Are Trend-y
Since a majority of the forex market will deal with the U.S. dollar, you can imagine that many of the news reports will cause U.S. dollar-based currency pairs to spike.
The US has the largest economy in the world, and as a result, speculators react strongly to U.S. news reports, even if it doesn’t cause a huge fundamental shift in the long run. What this means for your charts is that you will see several “spikes” even if there is a trend emerging. This can make it harder to spot trend or range indications.
The day to day economic activities of the U.S. can keep U.S. dollar based currencies such as EUR/USD (above) from making smooth trends.
Conversely, we can see that during the same date range, cross currency EUR/JPY made a much, much smoother ride to the top. This was probably due to less spikes that came from U.S. data.
So as you can see, both charts showed the euro rise during the same time period, but the one without the U.S. dollar (EUR/JPY) made for a much easier trade.
Our resident currency cross monster Cyclopip caught a hundred pips by riding EUR/JPY’s trend. Check out how caught that move! If you are a trend following kinda dude, then currency crosses may be easier to trade than the major pairs.
It will be easier for you to spot the trend and be more confident in your entry points because you know that these technical levels hold more than they do for the majors.
In the next section, we’ll discuss how playing with currency crosses can also allow you to take advantage of the interest rate differentials. Now that’s like a cherry on top of a sundae!
Trade Interest Rate Differentials
By selling currencies whose country has a lower interest rate against currencies whose country has a higher interest rate, you can profit from the interest rate differential (known as a carry trade) as well as price appreciation.
That’s like being able to get a frosted cupcake with sprinkles on top! That talks to you! Imagine how delicious that would taste!
Currency crosses offer many pairs with high interest rate differentials that are prime for these types of trades.
For example, take a look at the nice uptrend on AUD/JPY. If you had a long position on this pair, you would’ve made a hefty profit. On top of that, the interest rate differential between AUD and JPY was huge.
From 2002 to 2007, the Reserve Bank of Australia had raised rates to 6.25% while the BOJ kept their rates at 0%.
That means you made profits off your long position AND the interest rate differential on that trade! Now that’d be an awesome cash cow right there!
Later on in college (if your brain hasn’t exploded with all this forex knowledge by then), we’ll teach you more about carry trade.
We’ll teach you which ones will work and which ones won’t.
Be Careful Trading Obscure Currency Crosses
While the euro and yen crosses are the most liquid crosses, more currency crosses exist that don’t even include the U.S. dollar, euro, or the yen!
We’ll call these the “Obscure Currency Crosses”! If we were in school – come to think of it, we actually are in school! – the major pairs would be the jocks while the obscure currency crosses would be the eccentric emo kids or hipsters.
That’s because most forex traders would rather hang out with the cool crowd than the obscure crosses!
We’re talking about really weird combinations like AUD/CHF, AUD/NZD, CAD/CHF, and GBP/CHF. That’s why we call them obscure crosses. Trading in these pairs can be more difficult and riskier than trading euro or yen currency crosses.
Since very few forex traders trade them, transaction volume is much lower resulting in lower liquidity.
Due to the illiquid markets for these crosses, their prices can become quite volatile, so being stopped out on whipsaws can become a common occurrence.
Check out these screenshots of AUD/CHF and GBP/CHF:
You don’t want to get stopped out by those nasty spikes, do you? That’s why most forex traders usually put wider stops when trading these pairs.
But judging from the choppy movement of obscure crosses, it would really be tough to catch a good trade on these pairs. Unless you’re a currency cross guru like Cyclopip, of course!
See what we mean? Also, since these currency cross pairs aren’t traded too much by forex traders, the spreads on these pairs can be pretty wide.
If you want to trade these currency crosses, just be ready for some wild price swings and be willing to pay the price of the massive spread!
How to Trade Fundamentals With Currency Crosses
If strong economic data comes out of Australia, you might want to look at buying the AUD. Your first reaction might be to buy AUD/USD.
But what if at the same time, recent data also show the United States experiencing strong economic growth? Price action of AUD/USD may be flat. One option that you have is to match the AUD against the currency of an economy that isn’t doing so well….
Hmmmm… what could you do?
Ah! Thank the forex gods for currency crosses!
Let’s say you did some analysis, checked the economic calendar (shameless plug!) and you notice that the Japanese economy isn’t doing so good right now.
What do you do?
Of course, like any self-respecting bully, you jump all over this opportunity and go long AUD/JPY!
In the chart above, notice the relative strength of AUD/JPY vs. AUD/USD. You’re not limited to just these currency pairs, you could’ve compared AUD against like EUR, GBP, and CAD.
From there, you can look for the look for the weakest currency to trade against.
There’s nothing wrong with being a bully, at least not here at the School of Pipsology.
It’s your job as a forex trader to take advantage of certain opportunities so that you can put some silver dollars into your piggy bank.
Because of currency crosses, you now have the opportunity to match the currency of the best-performing economy against that of the weakest economy without having to deal with the U.S. dollar.
How to Trade a Synthetic Currency Pair and Why You Probably Shouldn’t
Sometimes institutional forex traders can’t trade certain currency crosses because they trade in such high volume that there isn’t enough liquidity to execute their order.
In order to execute their desired trade, they have to create a “synthetic pair“.
How to Create a Synthetic Currency Pair
Let’s say that an institutional forex trader wants to buy GBP/JPY but can’t because there isn’t enough liquidity. To execute this trade, they would have to buy both GBP/USD and USD/JPY (earlier in this lesson, we learned that these pairs are called its legs).
They are able to do this because there is plenty of liquidity in GBP/USD and USD/JPY which means they can make large orders.
If you’re a retail forex trader, and you wanted to pretend to trade like an institutional trader, then you could technically trade synthetic currency pairs as well.
But it wouldn’t be too smart. Ever since the great Al Gore “invented the internet,” technology has improved to the point now that even weird currency crosses like GBP/NZD or CHF/JPY can now be traded on your forex broker’s platform.
Aside from having access to a larger “menu” of currency pairs to trade, the spreads would be tighter on the crosses compared to the synthetic pair you’d create.
And let’s not forgot about margin use! Creating a synthetic currency pair requires you to open two separate positions and each position requires its own margin.
This locks up unnecessary capital in your trading account when you can simply trade the cross-currency and save on margin.
So unless you’re trading yards (forex slang term for one BILLION units), forget synthetic currency pairs and stick to currency crosses.
You will be savings yourself some pips (thanks to a tighter spread) as well as freeing up your capital so you can take on more trades.
Trading the Euro and Yen Crosses
After the U.S. dollar, the euro and yen are the most traded currencies.
And like the U.S. dollar, the euro and yen are also held as reserve currencies by different countries. So this makes the euro and yen crosses the most liquid outside of the U.S. dollar-based “majors.”
Trading the Euro Crosses
The most popular EUR crosses are EUR/JPY, EUR/GBP, and EUR/CHF.
News that affects the euro or Swiss franc will be felt more in EUR crosses than EUR/USD or USD/CHF.
U.K. news will greatly affect EUR/GBP.
Oddly enough, U.S. news plays a part in the movement of the EUR crosses. U.S. news makes strong moves in GBP/USD and USD/CHF.
This not only affects the price of the GBP and CHF against the USD, but it could also affect the GBP and CHF against the EUR. A big move higher in the USD will tend to see a higher EUR/CHF and EUR/GBP and the same goes for the opposite direction.
Confused? Ok ok…let’s break this down.
Let’s say that the U.S. shows positive economic data causing the USD to rise.
This means that GBP/USD would fall, driving the price of the GBP down. At the same time, USD/CHF would rise, also driving the price of the CHF down.
The drop in GBP price would then cause EUR/GBP to rise (since traders are selling off their GBP).
The drop in CHF price would also cause EUR/CHF to rise (since traders are selling off their CHF).
Conversely, this would also work in the opposite direction if the U.S. showed negative economic data.
Trading the Yen Crosses
The JPY is one of the more popular cross currencies and it is basically traded against all of the other major currencies.
GBP/JPY, AUD/JPY, and NZD/JPY are attractive carry trade currencies because they offer the highest interest rate differentials against the JPY. When trading JPY currency cross pairs, you should always keep an eye out on the USD/JPY.
When key levels are broken or resisted on this pair, it tends to spill over into the JPY cross pairs.
For example, if USD/JPY breaks out above a key resistance area, it means that traders are selling off their JPY.
This could prompt the selling of the JPY against other currencies. Therefore you could expect to see EUR/JPY, GBP/JPY, and other JPY crosses to rise as well.
Over recent years, this currency cross has become very popular, becoming highly correlated with the price of oil.
Canada is second largest owner of oil reserves and has benefited with the rise of oil prices.
On the other hand, Japan is heavily reliant on the importing of oil. In fact, over 99% of Japan’s crude oil is imported as it has almost no native oil reserves.
These two factors have caused an 87% positive correlation between the price of oil and CAD/JPY.
How to Use Currency Crosses to Trade the Majors
Even if you don’t ever want to trade the currency crosses and simply stick to trading the majors, you can use crosses to help you make better forex trading decisions. Here’s an example…
Currency crosses can provide clues about the relative strength of each major currency pair.
Let’s say you see a buy signal for EUR/USD and GBP/USD but you can only take one trade.
Which one do you take? Simply looking at your crystal ball and guessing isn’t likely to result in the right answer.
To find the right answer, you would look at EUR/GBP cross.
If EUR/GBP is trending downward, this indicates that the pound is relatively stronger than the euro at the moment. So the right answer would be to buy GBP/USD instead of EUR/USD due to the pound’s relative strength against the euro.
Since the euro is weaker, relative to the pound, if it proves to strengthen against the U.S. dollar, it is likely to strengthen LESS than the pound.
If the U.S. dollar weakens across the board, GBP/USD you would make more pips since it would rally higher than EUR/USD.
So GBP/USD is the better trade.
You can do this relative strength analysis on any of the major currency pairs.
Know Which Currency Cross to Use
Let’s say you’re bearish on the U.S. dollar. How will you trade?
- Can’t decide whether to buy EUR/USD or sell USD/CHF? Look at EUR/CHF.
- Can’t decide whether to buy USD/CHF or USD/JPY? Look at CHF/JPY.
- Can’t decide whether to buy EUR/USD or sell USD/JPY? Look at EUR/JPY.
- Can’t decide whether to buy GBP/USD or sell USD/CHF? Look at GBP/CHF.
- Can’t decide whether to buy GBP/USD or sell USD/JPY? Look at GBP/JPY.
So always remember, looking at currency cross pairs could give you an idea of the relative strength of a particular currency.
How Cross Currency Pairs Affect Dollar Pairs
Let’s pretend the Fed announces they will raise interest rates. The market quickly starts buying the U.S. dollar across all major currencies….EUR/USD and GBP/USD fall while USD/CHF and USD/JPY rise. You were short EUR/USD and were pleased to see price move in your favor making you some pips, but right before you were about to break out the cigar, you notice your friend who was long USD/JPY made a lot more pips than you.
You’re like “What’s up with that yo?”
You compare the charts of EUR/USD and USD/JPY and see that USD/JPY made the bigger move.
It broke through a major technical resistance level and shot up 200 pips while EUR/USD barely shot down 100 pips and failed to break a major support level. You’re thinking to yourself, “If the U.S. dollar was being bought across the board, then how come my EUR/USD trade looks so weak compared to my friend’s USD/JPY trade?”
This is due to the currency crosses! In this particular example, EUR/JPY.
When USD/JPY broke through its major resistance level (red dashed line and 101.00 handle), the combination of stop losses being hit and breakout traders jumping on the bandwagon pushed it even higher.
Since buying more USD/JPY weakens the yen, this would cause EUR/JPY (and possibly other yen-based pairs) to break through its major resistance level. once again hitting stops and attracting breakout traders, pushing EUR/JPY even higher. When resistance is broken, this results in stops being triggered along with breakout traders going long, pushing EUR/JPY even higher.
This causes the euro to strengthen and slows down the descent of your EUR/USD trade.
The EUR/JPY cross buying acts a “parachute” and this is why EUR/USD didn’t move as much or as fast as the USD/JPY.
So even if you only trade the major currencies, cross currency pairs still have an effect on your trades!
Summary: Currency Crosses
As you’ve learned, there are many, many trade opportunities presenting themselves in the forex market other than figuring out what the Greenback will do any given day.
Now you know how to find them! Here are a couple of things to remember: Crosses give forex traders more pairs to trade, which means more trading opportunities.
We normally see cleaner trends and ranges on currency crosses than we do on majors.
You can take advantage of interest rate differentials by trading currency crosses. Do your due diligence and analysis and match the strong currencies against the weak ones.
If the pair you are looking to trade isn’t available with your broker, don’t worry. You know how to create a synthetic pair by simultaneously going long or short two major pairs to create one currency cross.
The most popular euro crosses are the EUR/JPY, EUR/GBP, and EUR/CHF.
GBP/JPY, AUD/JPY, and NZD/JPY are attractive carry trade currencies because they offer the highest interest rate differentials against the JPY. When trading obscure currency crosses, watch out for wild price swings and wider spreads.
Even if you wanna stick to the majors, you can make use of currency crosses to help you decide between which pairs to trade as crosses can signal which currency is stronger.
Don’t forget that moves in currency cross pairs can have an effect on the majors.
Last tip; Please be conscientious of the pip value of the cross you are trading. Some crosses will have a higher or lower pip value than the majors. This information is good to know for your risk analysis.
So, on the days you may not see any opportunities in the major pairs, or if you want to avoid the volatility of a US news event, check out some the currency crosses. You may never know what you may find!
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- Warren Buffett
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