October 16, 2017
Currency crosses are a popular choice among traders who trade the news. Simply said, you want to match a good performing currency with a currency that performs not that well. If, for example, the Bank of England decides to raise interest rates, your first thought might be to buy GBP/USD. However, what if the US economy also performs well and the US dollar appreciates? The price action on GBP/USD could be flat.
With currency crosses, you could match GBP with a currency that doesn’t perform that well. Let’s say Japan reports economic data that missed market expectations. Buying the GBP/JPY could be a much better choice than buying GBP/USD in this case.
Synthetic Currency Pairs – And Why You Shouldn’t Trade them
Synthetic currency pairs are usually created by big institutional traders, who want to place large orders on the forex market but can’t due to the lack of liquidity in some currency pairs.
Let’s say a big trader wants to place a large long order on GBP/CHF. As the pair isn’t as liquid as the majors, the big trader creates a synthetic pair by buying both GBP/USD (buy GBP, sell USD), and USD/CHF (buy USD, sell CHF), which both are highly liquid pairs. The sell and buy USD positions cancel each other out, and the institutional trader is left with a long GBP/CHF position.
However, retail traders shouldn’t try to replicate those large traders. First, many brokers often a variety of cross pairs so that you can immediately place an order on any cross pair you like, paying relatively tight spreads compared to synthetic pairs. And second, as a synthetic pair involves the opening of two separate positions, you would have to lock up unnecessary capital of your trading account which increases the chances of a margin call.
Unless you have millions available to trade on forex, it’s better not to mess around with synthetic currency pairs.
The Characteristics of Major Currency Crosses
As noted earlier, the euro and yen are the most traded currencies after the US dollar. And as many countries also hold a significant amount of euro and yen as their reserve currencies, they’re also among the most liquid currencies.
Euro crosses: Euro crosses include all pairs that include the euro as the base or counter currency, but exclude the US dollar. Examples of euro crosses are EUR/JPY, EUR/CHF and EUR/GBP. Any news from these countries tend to have a much larger impact on these pairs then US news tend to have. Switzerland and Great Britain, for example, trade the most with the Eurozone, and traders watch for economic releases from these countries to determine whether their currencies will raise of fall against the euro. The Brexit vote in 2016, for example, had a big impact on the EUR/GBP pair, as the following chart shows.
Yen crosses: Beside the euro, the Japanese yen is also a popular currency in cross pairs. They include EUR/JPY, GBP/JPY, AUD/JPY and NZD/JPY. Nevertheless, traders should also follow the USD/JPY pair, as a break of major support and resistance levels on this pair tends to spill over to yes crosses as well. This means, if the yen is appreciating in USD/JPY, it might also appreciate across yen crosses, and vice versa. The yen crosses are also often used for carry trades, as interest rates on the yen have long been among the smallest in the world. The AUD/JPY pair, which we already mentioned, was a popular carry trade choice. The next chart shows the AUD/JPY carry trade until 2007.
How to Use Crosses to Trade the Majors?
Currency crosses can provide valuable clues about the relative strength of major currency pairs. For example, if you see potential trade setups to go long on GBP/USD or short on USD/JPY, how would you decide which trade to take? An answer to this might be hidden in currency crosses, specifically the GBP/JPY cross. If the pound is relatively stronger than the yen, i.e. the cross pair is trending upwards, this might be a signal to go long on GBP/USD.
Test Your Knowledge: Trading with Fundamental Announcements
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Trading with Fundamental Announcements
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