Cross Currency Pairs in Forex

Cross currency pairs are an important part of Forex trading. Unlike major pairs, they do not involve the US dollar. Instead, they pair other currencies directly with each other.

This creates unique trading opportunities and can reduce reliance on the dollar. In this article, we’ll explain what cross currency pairs are, how they work, and why they matter for traders. Let’s get started!

What are Cross Currency Pairs

Cross currency pairs, also known as currency crosses, are forex pairs that don’t include the U.S. dollar (USD). Instead, they consist of two non-USD currencies traded against each other.

For instance:

The EUR/JPY (Euro/Japanese Yen) and GBP/CHF (British Pound/Swiss Franc) are popular cross pairs.

These pairs emerged from the need to simplify currency conversions. Before crosses, traders had to use two separate USD pairs to exchange between non-USD currencies.

Now, cross pairs allow direct trading between these currencies. This makes the process more efficient and cost-effective.

Popular Cross Currency Pairs:

Some widely traded cross currency pairs include:

1. EUR/GBP (Euro/British Pound)
2. EUR/JPY (Euro/Japanese Yen)
3. GBP/JPY (British Pound/Japanese Yen)
4. EUR/CHF (Euro/Swiss Franc)
5. AUD/NZD (Australian Dollar/New Zealand Dollar)

These pairs often represent major economies. They offer unique trading opportunities based on their economic relationships and market dynamics.

Advantages of Trading Cross Pairs:

Trading cross currency pairs comes with several benefits:

1. Diversification: Cross pairs allow you to diversify your portfolio beyond USD-based pairs.
2. Unique opportunities: They offer trading possibilities based on specific economic relationships between two countries.
3. Reduced exposure to USD fluctuations: Cross pairs are less affected by USD movements.
4. Lower correlation: They often move independently of major USD pairs. This provides alternative trade setups.

Challenges of Trading Cross Pairs:

However, cross currency pairs also present some challenges:

1. Wider spreads: Cross pairs typically have larger bid-ask spreads compared to major USD pairs.
2. Lower liquidity: They may have less trading volume. So, it can impact order execution.
3. Increased volatility: Some crosses can experience sharp price movements, (especially during economic events.)
4. Complex analysis: Trading crosses requires understanding the economic factors of both currencies involved.

How to Trade Cross Currency Pairs:

To trade cross currency pairs effectively, follow these steps:

1. Choose your pair: Select a cross pair based on your analysis and trading goals.
2. Analyze both economies: Study the economic factors affecting both currencies in the pair.
3. Monitor relevant news: Stay informed about events that could impact either currency.
4. Use technical analysis: Apply chart patterns, indicators, and other technical tools to identify potential trade setups.
5. Manage your risk: Use appropriate position sizing and implement stop-loss orders to protect your capital.

Examples and Calculations:

Let’s look at a simple example of trading the EUR/GBP cross pair:

Suppose the current EUR/GBP exchange rate is 0.8600. This means 1 Euro is worth 0.8600 British Pounds.

If you believe the Euro will strengthen against the Pound, you might buy 10,000 EUR/GBP at 0.8600.

Your position value would be:
10,000 x 0.8600 = 8,600 GBP

If the exchange rate moves to 0.8650, your new position value would be:
10,000 x 0.8650 = 8,650 GBP

Your profit would be:
8,650 GBP – 8,600 GBP = 50 GBP

On the other hand, if you think the Pound will strengthen against the Euro, you could sell the EUR/GBP pair. The calculations would be similar. But, your profit would come from a decrease in the exchange rate.

Conclusion:

Cross currency pairs offer great opportunities for Forex traders beyond USD pairs. By learning how these pairs work and applying good risk management, you can enhance your trading portfolio and take advantage of unique market movements.

To succeed with cross currency pairs, keep learning and practicing. Start with paper trading or a demo account to get familiar with them before risking real money.

As you gain experience, you’ll see how cross currency trading can improve your overall Forex strategy.

Happy trading!