I. Basic Concepts of Cross-Currency
Cross-currency pairs do not include the US dollar, as opposed to direct currency pairs involving the dollar. Why not trade cross-currency pairs? You may already meet several conditions to trade cross currencies, but it’s still worth discussing why beginners should start with direct currency pairs.
Second, trading direct currency pairs requires attention to the fundamentals of two countries, one of which is the US. Economic data from the US is relatively easy to obtain, whereas cross-currency pairs require attention to the fundamentals of three countries, including the two involved in the pair plus the US. Many central banks hold US dollars, and commodities are priced in dollars, so economic analysis is only complete considering the US economy and monetary policy.
Third, it’s easier to collect trading experiences from various resources for direct currency pairs, while there are fewer forex traders and incomplete discussions on cross-currency pairs, which limits experience gathering. However, it’s still necessary to introduce some knowledge about cross-currencies and provide valuable trading experiences.
In fact, if we study and trade certain cross currencies over the long term, accumulating relevant experience, you as a forex trader will gain unique perspectives and trading strategies. After all, there are many special opportunities in cross currencies. We hope you can discover more cross-currency trading strategies.
We will clear the fog on cross-currency pairs for you and provide some effective trading advice. Simply put, cross-currency pairs are those where neither the quote currency nor the base currency is the US dollar. For example, significant cross-currency pairs include GBP/CHF, GBP/JPY, EUR/JPY, EUR/CAD, AUD/NZD, etc.
II. Returning to Fundamental Analysis
The main goal of fundamental analysis is to find currency pairs that pair a fundamentally strong currency with a fundamentally weak one. First, identify a country with weak fundamentals, which could be experiencing economic recession.
In essence, one country should be viewed positively, and the other negatively. Additionally, the currencies of these countries must be among the major traded currencies for convenient operation in the forex market.
Let’s look at a real example: On January 1, 2007, the Bank of England and the European Central Bank were set to announce their respective interest rate policies. Before the announcement, the forex market widely expected the European Central Bank to raise rates, while the Bank of England was expected to keep rates unchanged.
Surprisingly, the European Central Bank kept rates unchanged due to concerns about slowing economic growth, while the UK raised rates to 5.25%. Given such fundamental opportunities, why not trade a cross-currency pair composed of the British pound and the euro instead of a dollar-based pair? Consider the following hypothetical situation: US retail sales data was published shortly after the interest rate decisions.
If you expect the euro to weaken and therefore short EUR/USD, but the US retail data turns out to be unfavorable for the dollar, you should sell the dollar. Or if you are bullish on the pound and decide to go long, but then the US retail data indicates a strong US economy, your bullish stance on the pound would prove to be a bad decision.
After the interest rate policy announcement, we know that the outlook for the euro weakened, while the pound was favored. Why not short EUR/GBP? If you operate this way, you avoid the impact of the subsequent US data and can achieve a positive interest rate differential. Assuming you are short EUR/GBP, you could profit.
As you can see, if you short around 0.6650, about an hour after the interest rate announcement, you could capture the slow movement of the exchange rate towards 0.6600, yielding about 50 pips of profit. This is just one example of finding weaker currencies to pair with stronger ones. With six major non-US currencies available, there are ample opportunities to find such trading pairs.
III. Synthetic Currency Pairs in Forex
Suppose you’ve done your analysis and concluded that the British pound is strong while the Swiss franc is weak, or the Australian dollar is strong, and the Canadian dollar is weak.
But when you check your trading platform, you find that your broker doesn’t offer GBP/CHF or AUD/CAD. Have you lost this trading opportunity? No, you can create a synthetic currency pair to go long on GBP/CHF or AUD/CAD.
Creating synthetic currency pairs using four major currency pairs and three commodity currencies is relatively easy. The operation involves buying or selling two pairs of currencies with the same position size at the same time.
For example, if you want to go long on GBP/CHF, you must buy GBP/USD and USD/CHF simultaneously. Let’s demonstrate this process in detail. The only thing to note is that you must trade the same volume simultaneously.
Using GBP/CHF as an example, let’s assume the current GBP/USD rate is 1.9000 and the USD/CHF rate is 1.2500, and you decide to buy contracts worth $10,000 for each currency pair. Here’s what you would do: For currency pairs where the dollar is the quote currency, you should divide the dollar value you want to trade by the exchange rate level.
This calculation applies to pairs like AUD/USD, GBP/USD, EUR/USD, etc. Suppose you want to trade a $10,000 contract, then divide $10,000 by the GBP/USD rate of 1.9000, resulting in 5263 pounds. For currency pairs where the dollar is the base currency, you trade the dollar value directly because you are trading dollars.
That is, trade a $10,000 USD/CHF contract. Therefore, to buy $10,000 worth of GBP/CHF, we buy 5.263 units of GBP/USD and 10,000 units of USD/CHF. Of course, you can extrapolate this principle to determine the necessary purchases of GBP/USD and USD/CHF for other trading sizes.
IV. Summary of Navigating the Forex Market
As you can see, there are many trading opportunities in the forex market. It also tells you how to creatively use existing tools to take advantage of special opportunities.
However, you need to remember a few points: You must strive to find currency pairs composed of fundamentally weak currencies and fundamentally strong currencies. If the currency pair you find is not offered on your trading platform, don’t be discouraged; you can use synthetic currency pairs to complete similar investment plans.
Pay attention to the pip value of your trading currency, such as EUR/GBP, where each pip is approximately $19.70. Some currency pairs have higher pip values than major currency pairs, while others have lower pip values. Knowing this information helps you with risk analysis and capital management.
Perhaps on some days, you don’t find any attractive opportunities in the major currency pairs, or maybe you want to avoid the impact of US data and news events, then you can look at cross-currency pairs.
Of course, we hope you can find your best trading opportunities. Always analyze potential costs and benefits, and be mindful of these when trading cross currencies.
