As every forex enthusiast knows, foreign exchange trades are conducted using what’s known as ‘currency pairs’, which give the value of the first — the ‘base’ currency, or the one you’re selling — in relation to another known as the ‘counter’ currency (which you are looking to buy).
The six major pairs — EUR/USD, GBP/USD, USD/CAD, USD/JPY, USD/CHF and AUD/USD — are thought to account for up to 90% of all trades across the global forex market. However, these are far from the only currency combinations available for investors!
Another subset of currency pairs, known as ‘crosses’, are also commonly used by traders — let’s explore them in more detail:
What is a Cross Pair in Forex?
In simple terms, a ‘cross’ pair is one that does not contain the US dollar (USD) as one half of the transaction. Crosses often use another prominent major currency in place of the dollar, for example the euro (EUR) or Japanese yen (JPY), and are often labelled as such — i.e. a ‘euro cross’ or ‘yen cross’, for example EUR/GBP, GBP/JPY and EUR/CHF.
Cross pairs are a relatively new phenomenon; after World War 2, the world’s currencies were benchmarked against the US dollar due to its status as the global reserve currency and its strong relationship to the price of gold.
This meant that a trader wanting to convert two non-USD currencies — for instance, swapping the British pound (GBP) for the Canadian dollar (CAD) — would first have to change their GBP into USD before then converting into CAD.
However, since the end of the Bretton Woods Agreement in the early 1970s, global exchange rates have shifted from the rigid Gold Standard arrangement into a much more free-flowing format that has allowed currency investors to bypass the US dollar entirely, leading to the free trading of cross pairs across the global forex market that we see today.
Further reading: https://blackwellglobal.com/what-is-cross-currency-trading/
How are Currency Cross Rates Calculated?
In the modern technologically advanced era, it’s not entirely necessary for investors to know how to calculate the bid and ask prices for cross pairs as most reputable brokers will do the technical work for you! Nonetheless, if you’re a true budding forex buff who wants to understand the full ins and outs, here’s the maths involved:
Let’s take the popular cross pair of the British pound and Japanese yen (GBP/JPY) to use as our example. In order to calculate the rates for this cross pair, we’d first take a look at the buying and selling prices for both GBP/USD and USD/JPY — the corresponding major pair (i.e. the currency twinned with the US dollar) for both parts of our cross, comprising what’s known colloquially as the ‘legs’ of the GBP/JPY pair.
Once you have both sets of prices to hand, you simply multiply either the two bid prices or two ask prices of the cross pair’s legs — depending on which value you want — to get the corresponding price for your cross.
For instance, let’s say GBP/USD had a bid price of 1.5520 and an ask price of 1.5530, while USD/JPY had a bid price of 88.50 and an ask price of 88.75; in this case, the maths would be as follows:
As you can see, it’s actually a forgivingly simple process — but one that’s still always nice to have automated for you!
What are the Advantages of Trading Cross Pairs?
The most common-sense reason for adding cross pairs into your trading arsenal is the wider array of opportunities it affords you; when trading solely majors — GBP/USD, EUR/USD, USD/CHF and so on — you’re essentially forced into taking one side of a binary, i.e. being bullish or bearish towards the USD at that moment in time, which limits the scope of your speculation abilities and leaves you at the mercy of USD-centric fundamentals around the clock.
Cross currency pairs, by contrast, are useful outlet for investors wishing to express their bullish or bearish sentiment regarding a particular world event or specific relationship between two countries away from US economics and politics. Perhaps the most prominent recent example of this phenomenon is how the Brexit developments of the past few years have given a new dimension to trading the EUR/GBP pair, with the market becoming increasingly sensitive to news stemming from the ongoing trade negotiations, as well as wider speculation over the nature of the UK and European Union’s (EU) future relationship.
Furthermore, cross pairs are commonly utilised in carry trades as a means of profiting off the interest rate differentials of the two currencies; one such tactic would be to a sum of a low-interest currency such as JPY and re-invest these funds into a much higher yielding currency such as the AUD or NZD.
It’s also worth noting that the steady increase in volume of cross currency pair trades since the beginning of the internet era means that spreads have generally become tighter over time, resulting in less slippage and lower transaction costs than were previously associated with trading less liquid instruments.
Further reading: https://www.fxtradingrevolution.com/forex-blog/analyzing-and-trading-cross-currency-pairs-introduction
What are the Risks of Trading Cross Pairs?
Whilst it can be freeing to trade without the USD’s influence taking centre stage, by the same token it’s equally true that of the obvious downsides of trading cross pairs is that you don’t have the tried-and-tested stability of the USD anchoring one side of the transaction.
Instead, by trading crosses you’re effectively betting on the fortunes of two more volatile, less developed economies at once — and consequently these markets can often be more unpredictable, so it’s vital cross traders stay up-to-date with the political and economic climates they’re dealing with at all times.
What’s more, despite advancements in technology closing the gap somewhat, cross pairs still usually have a higher transaction rate overall than major pairs due to the wider bid-ask spreads. They also have a lower degree of liquidity than majors as they simply aren’t as frequently traded, which means erratic changes in direction (colloquially termed ‘whipsaws’) are more common; for this reason, some traders elect to use wider stops (and budget accordingly) on cross trades to avoid being stopped out by fleeting market reversals.
Due to these added challenges, it’s advisable that novice speculators get comfortable trading with major pairs first before diving into the more temperamental majors — and even experts should prepare for shock directional swings when they least expect them!
Further reading: https://capital.com/cross-currency-pairs-forex-trading-without-us-dollars
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The content contained herein does not construe any form of advice and the user must not take this as such. We do not accept any liability for the direct or indirect usage of the content held in this article. We strongly advise that you obtain independent financial, legal and tax advice before proceeding with any currency or spot metals trades.
