A cross currency pair is a pair that does not include the US dollar. While the US dollar is the most liquid currency, accounting for the majority of trading volume in global markets, there are additional opportunities for traders looking to incorporate cross-currency pairs into their trading arsenal.
By trading crosses in combination with major currency pairs, you can significantly increase the number of trading instruments available and gain more trading opportunities. Although the pros of trading crosses outweigh the cons, there are a number of features you should be aware of.
A little history
Currency trading has evolved over the years. After the collapse of the gold standard, the US dollar became the main reserve currency. Over time, the dollar became the most liquid currency, forming the basis for all major currency pairs, the so-called majors:
- Euro – EUR.
- Yen – JPY.
- British pound – GBP.
- Australian dollar – AUD.
- Canadian dollar – CAD.
- Swiss franc – CHF.
Major currency pairs such as EUR/JPY or EUR/GBP provide traders with reliable trading liquidity.
Correlated currency pairs
Although the dollar represents the currency of the world's largest economy, there are dozens of trading opportunities with currency pairs that can take advantage of the relative value of one currency to another. An excellent example of two currencies that were pegged to each other was the euro and the British pound.
The Brexit vote saw the EUR/GBP currency pair rise 13% in two weeks. Active trading volumes generate billions of dollars, so the liquidity that EUR/GBP has makes it one of the best currency cross pairs to trade.
Typically, countries that are economically interconnected have currencies that move in tandem. You can consider trading this type of currency pair in two ways. For example, you can use Bollinger Bands or the RSI indicator when prices are in consolidation. Or look for periods of unexpected surges in volatility and try to trade for a breakout.
The advantage of trading highly correlated currency pairs is that they offer greater liquidity in most time zones. The spread for highly correlated major crosses such as EUR/GBP will be relatively tight and will provide ample liquidity to enter and exit positions.
More trading tools
One of the main benefits of using cross pairs in forex is that these tools provide you with more trading options. If you only trade major currency pairs, you only have 6 trading instruments. If you add crosses as well, you can create dozens of available combinations.
Experienced traders are constantly looking for new trading opportunities. Historically, currency markets will trend about 30% of the time. This means that 70% of the time, currency markets are range bound. This is especially true for highly correlated cross-pairs.
By adding cross-currency pairs to your trading arsenal, you have enough liquidity to develop and implement your trading strategy.
Both fundamental and technical traders can recognize this chart as representing a historical moment in the forex market. The image above shows the EURCHF chart from the beginning of 2013 to the end of 2016. EUR/CHF is a perfect example of a cross-currency pair that traded in a range for an extended period of time, only to experience huge volatility and then return to its historical calm.
A sharp rise in the value of the Swiss franc occurred in early 2015 when the Swiss National Bank announced it would scrap its previous three-year peg of 1.20 Swiss francs per euro.
This scenario had a wide range of negative consequences for brokers in the foreign exchange market. This Black Swan caused huge losses for traders, and brokers found themselves in a situation where they needed to recover money from clients who had no intention of putting additional funds into their accounts. Obviously, not everyone in this situation was a loser, and there were those cross traders who traded short and benefited significantly from this historical volatility.
Pairs trading
Another advantage of trading cross pairs in forex is that crosses provide you with the opportunity to buy along with sell the strongest and weakest currencies that exist in the market. The concept is similar to pairs trading, where you try to find securities that are currently priced below market value.
Countries with similar exports are also great pairings to team up with. For example, the Canadian dollar and the Australian dollar are commodity currencies. Their economy is highly dependent on commodity prices. If you think the Canadian dollar is poised for a move higher, you may want to consider a pairs trade where you sell or buy AUD/CAD.
Cross currency spread
While almost all major currencies provide ample liquidity with negligible transaction costs, some cross-currencies can be more costly to trade. This generally won't apply to a currency like EUR/GBP, but if you decide you want to trade a currency pair with weaker liquidity, you'll likely pay a few extra pips to get in and out of each trade.
Additionally, currency pairs that experience volatility against the dollar will also likely experience increased volatility as a cross pair. With this type of crossover, such as AUD/JPY or CAD/JPY, the bid spread will be wider.
The time zone and trading session in which you place your transaction must be taken into account when trading currencies. In the early Asian hours, many European crosses and the Canadian dollar have weak liquidity. To protect themselves from low liquidity, brokers will charge a larger spread than usual.
The spread on major currency pairs such as EUR/USD can be as low as 0.5 pips. On many cross-currency pairs, the spread can reach 5 or even 10 pips. This allows the broker to buy on the demand order and try to sell on the offer for a profit. Of course, the market can quickly move against the broker, but overall this is a reliable way for brokers to generate income.
Cross pairs and interest rates
Foreign exchange markets tend to be driven by interest rates over the long term. Higher interest rates attract investors to a particular currency. Investors are faced with the question of when they evaluate a currency pair relative to which currency will produce returns if the market does not move. Carry is a term that describes whether you will earn interest when you close a deal.
Each country has its own interest rate. For example, Japanese government bonds have a specific interest rate based on the value of the bond. The UK 10 year bond also has a corresponding interest rate. If the yield on a UK 10-year bond is higher than the interest rate on a Japanese government bond, you will receive the difference between the two interest rates if you buy GBP/JPY with a settlement date in 10 years. Obviously, most forex traders do not plan to trade forex for 10 years, but the concept is valid for any time period.
The spot rate is the most common. If you place a currency transaction, you agree to exchange the currency within one business day. Any settlement period longer than one day requires the addition of forward points, which are added or subtracted from the foreign exchange transaction to account for differences in interest rates.
Fundamental Analysis
When trading cross pairs, it is useful to analyze economic data as differences in interest rates can play a role in determining the future direction of a currency pair. The process of evaluating interest rates and other important economic data is called fundamental analysis. When analyzing economic data for a particular country, you must research and determine what factors contribute to economic growth and how this growth will affect the development of the country's economy.
Typically, when a country's economy is thriving, one would expect the demand for the country's currency and the corresponding exchange rate to rise. On the other hand, if a country's economy is underperforming and shows weak economic data, the demand for that country's currency will decline. Using fundamental analysis, you can analyze the correlation between economic data and the value of currencies.
Traders generally take for granted the stability of the US economy compared to other countries. Pair crosses have an added level of risk because instead of assessing political and financial instability in one country against the US dollar, you are analyzing two other economies.
Exotic currency pairs
Currency pairs are divided into several categories. You have majors, crosses and exotic currency pairs.
Exotic currency pairs are currency pairs that are not frequently traded on the foreign exchange market. Typically, exotic currency pairs are those from developing countries such as areas of Asia, the Middle East, South America and Africa. Exotic currency pairs tend to have larger spreads and usually require a longer-term strategy.
One of the advantages of trading exotic cross-currency pairs is the return differential in favor of a less stable currency. This type of strategy is very tempting, but can be quite risky.
Additionally, when a country has a relatively weak currency, its goods and services are inexpensive compared to its competitors. This could be very attractive to a central bank that is trying to stimulate economic growth.
Sometimes a country will peg its currency to the currencies of others to avoid appreciation, which can reduce export growth. If a country pegs its currency to other currencies, the central bank is usually responsible for daily trading activity that keeps the currency at the same price level.
An example of this scenario was the Thai bhat, which pegged its currency to the yen, dollar and euro. This peg remained in effect until 1998, when the Thai government decided that it was too expensive to maintain the peg to other currencies.
Before this period, some traders used the strategy of buying Thai baht and simultaneously selling US dollars, euros and yen to gain interest rate differentials. This is called a carry trade.
Forex crosses – signal strength
There are situations when crosses show a signal that meets all the criteria, it is so perfect that we can directly hear it asking us to open a trade, which is why we must know how to determine the strength of such signals.
A bullish pin pair has formed on the EUR/JPY chart, while it falsely broke the low of the previous candle, which is an additional signal to open a buy transaction.
But we want to determine the strength of this signal, since after all, this currency pair is a cross, and it would be great to get some confirmation in favor of the bulls. In order for us to do everything correctly, we need to divide this pair into two main ones, but how is this done?
This will not be a difficult task if you remember that every major pair has USD in its name. Now everything is falling into place. The place of JPY in EUR/JPY is taken by USD – we get EUR/USD. The place of EUR in EUR/JPY is taken by USD – we get USD/JPY. Everything is very simple and logical.
A bullish pin bar has formed on the EUR/USD chart.
This signal tells us that the Euro is now very strong and it is better to buy this currency. But the analysis will not be complete if we do not consider the situation on USD/JPY.
In the USD/JPY pair we can see that we also have a bullish pin bar formed here.
This pin indicates the strength of the USD against the JPY, which suggests that the Japanese is now weak and needs to be sold.
EUR is a strong currency and JPY is weak. Since we received a bullish signal for EUR/JPY, which agrees with our analysis, we can safely open a buy trade.
Analyzing currency pairs
Let's learn how to determine the strength of any price action signal received on a major currency pair.
Very often dubious trading signals appear on the charts, and we do not understand why our intuition is against them, because everything is according to the rules, but we are full of doubts. At such moments, we really want something to confirm the strength of this or that entry, and we could open a position with confidence. Don't despair, there is a way out!
Below is a chart of the EUR/USD currency pair, daily timeframe. So, on this day we had a bullish Pin Bar, signaling market growth.
But we would like to make sure of its reliability, and for this we need to analyze other crosses, in our case we will analyze as many as 3 for greater confidence.
First, let's take a look at the EUR/JPY chart to assess the overall health of the Euro.
We see that a bullish Pin Bar has formed on the chart, indicating to us the strength of the EUR, which is a plus to our signal for EUR/USD.
Let's continue to analyze the charts and try to assess the strength of the dollar, since it is also present in the name of the pair. So, USD/CHF:
And what do we see here!? A bearish Pin Bar has formed, signaling the weakness of the dollar. At the moment we already have two advantages:
- Euro strength according to EUR/JPY.
- Dollar weakness in USD/CHF.
Great, let's be completely sure of the quality of our signal and analyze USD/CAD as well:
Voila! The market broke through the support level, and the price settled behind it, which also indicates the weakness of the dollar. As a result, we get the following picture:
This is a signal with a high probability of being processed by take profit. We open a buy deal and earn our 80 points of profit.
This analysis is quite difficult to understand, since it is necessary to select the correct auxiliary currency pairs; for EUR/USD you already know: EUR/JPY, USD/CHF, USD/CAD.
We use crosses to identify the best price action signal
It often happens that we receive two signals at once to open a position on two different currency pairs, and the question arises in our heads about the best signal, because some traders do not open several transactions at once, so as not to load their deposit and not risk too much.
The market has a wide variety of currency pairs, but there are not so many main ones. It would seem that if we leave only the main ones for price action trading, then we will be able to receive a sufficient number of signals to somehow increase our deposit. But in this case, one point is missed when we get two entry opportunities at once and we are faced with a choice, which currency pair to trade? After all, the problem is that by trading two at once, we can close the first one in profit, and the second one at a loss, and the total result will be zero. Or something else will happen: we open one transaction, it will close at a loss, and based on another signal we could get a good interest on our deposit. Well, the third option: we open a trade, it goes up by 10 points, and for another pair at 120 our disappointment knows no bounds.
So, to prevent this kind of situation from happening, we will learn how to use crosses on Forex to determine the strength of a particular currency. Begin!
We will analyze two bearish signals one bullish cross signal at a time. Therefore, if you had a hard time with problems at school, then arm yourself with a pen and a piece of paper to slowly figure it out. In any case, I will try to describe everything as detailed and intelligibly as possible.
Below is a chart of the AUD/USD currency pair, daily timeframe. On April 1, 2014, the price drew a bearish Pin Bar, which is a sell signal.
On the same day, we discovered another bearish Pin, but for the NZD/USD currency pair.
Due to the fact that we cannot open two orders at once, we must choose the signal with the greatest potential for achieving a profit level. In order for us to do everything correctly, we should look at the AUD/NZD cross pair and find out which currency is stronger.
A bullish Pin Bar has formed on the chart, indicating the growth of the Australian dollar against the New Zealander. Now it will be a little confusing, but try to figure it out. If the AUD is stronger than the NZD, then the Aussie is more likely to rise than the New Zealander, and if the NZD is weaker than the AUD, then this weakness can be perceived as the bulls being unable to push the price higher. And if the bulls are unable to do this, and we have a bearish signal on the NZD/USD pair, then most likely a decline will occur on NZD/USD. And since AUD is a strong currency, you should not consider its sell signal reliable for AUD/USD.
Based on all this, we decide that it is best to trade NZD/USD. Let's take a look at what happened on these currency pairs.
We were right, the signal turned out to be weak and the market began to rise, which would lead to losses.
The market was down a significant 120 points in two days.
As you can see, crosses help in analyzing the current situation for major currency pairs. The material is not that difficult to learn, but it is still worth practicing. Here are a couple of simple problems for you to practice:
- We received buy signals for EUR/USD and GBP/USD, and we noticed a sell signal for EUR/GBP. Which currency pair will you trade?
- We received sell signals for AUD/USD, NZD/USD and AUD/NZD. Which currency pair will you trade?
We trade with caution
There are much more cross currency pairs than the main ones, and those traders who switched to price action trading, which involves concluding transactions on D1, decide to compensate for the number of orders that they had on the M5-H1 timeframes by the number of currency pairs, including Forex crosses are included.
After that, they receive two signals for the CAD/JPY and USD/JPY currency pairs; by chance, these signals are opposite to each other, for the first pair a Bullish Pin Bar, and for the second a Bearish Pin Bar. The first thing that comes to the mind of an inexperienced trader is: Hurray! My time has come, it’s time to make a bunch of money, otherwise my wife wants to go to the Maldives!
That's it, two opposite orders are opened, our hero goes to bed with the hope that tomorrow he will have a couple of additional thousand dollars on deposit. No matter how it is!
The problem is that the price is more likely to move in the direction that the main currency pair is pointing, in our case USD/JPY. This is because most traders watch it, and where there are traders, there is money, and where there is money, there is a greater likelihood of moving the market in the required direction.
You should not think of each currency pair as if it is in no way connected with other pairs, because the connection is direct. And if the pound is bought somewhere, then most likely GBP will also grow on another currency pair.
So it turns out that our hero wakes up with a zero result, or receives two losses, and it’s better not to think about what his wife will say about this.
Below is a chart of the EUR/USD currency pair, daily timeframe. The lower border of the flat, which is broken by the candle for August 19, is clearly visible. This market behavior is perceived by traders as an excellent opportunity to open sell orders. Next, we can see a strong decline in the price, because everything is correct, everyone sold EUR, which provoked a fall.
Now let’s look at an example of the EUR/AUD currency pair for the same period. I would like to note right away that this pair is a cross pair, which makes it secondary in relation to EUR/USD. On the chart we can see the emergence of a bullish Pin Bar at the support level, which is a fairly strong signal to open buy transactions. I am sure that many traders did this, because I received this transaction for analysis from my students. But then the market fell by 514 points, something went wrong.
The fact is that this pair is secondary compared to EUR/USD. And on the main currency pair we received a bearish signal, which triggered the sale of the Euro, and this affected EUR/AUD, because all pairs are interconnected with each other, but the main currency pair has a greater influence, since there is a lot of money there.
