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I’ve got a quick question from a subscriber saying that they see that we normally, or mostly, have the major currency pairs in focus, and is asking whether it’s okay for them to also consider trading cross currency pairs.
So, thanks for the question. Let’s jump into this one because there is more to the answer than just a quick yes or a no.
Firstly, for those who might not be aware, currency pairs are usually divided into three categories. So you have your majors, your crosses, and then of course you exotics.
Now, currency pairs are considered as a major pair when they consist of the U.S. dollar and basically paired with another major economy currency such as the euro or the pound or the kiwi or the aussie or the CAD or the Swiss franc, or the Japanese yen.
Then currency pairs are called crosses or considered as cross pairs when they consist of two major economy currencies that does not include the U.S. dollar, right?
So that would be something like the aussie franc, the aussie yen, the CAD yen, the euro pound, euro yen, euro aussie, et cetera. And finally, we also have the exotics. They are simply any developing market currency paired with a developed country currency. So maybe think of the USD ZAR or the euro NOK, etc. Now, there are a few reasons why trading the majors, the major currency pairs, have advantages.
Firstly, due to their importance in terms of actual daily trading volume, they are usually very liquid pairs, which means that they have far better order execution as well as better trading costs.
So, remember the U.S. dollar makes up about 80% of all foreign exchange transactions per day. So, pairing the dollar with any one of the other major economy currencies means there’s far more liquidity available.
Comparing that to the cross currency pairs to your question, the crosses don’t contain the U.S. dollar, which means they will have far less liquidity compared to the major currency pairs. And what they lack in liquidity, they can often make up in volatility, which is not always a good thing of course.
The increase in volatility is often due to the thinner liquidity, which means that these pairs can have violent swings and very often much wider volatility ranges compared to the major currency pairs. Now, this of course isn’t necessarily always a bad thing.
You can always just better adjust positions when it comes to trading these type of pairs. But of course, sometimes these violent swings can be tricky to trade and navigate. And due to their thinner liquidity and higher volatility, they often are more expensive to trade in terms of trading costs.
Now, does that mean that you shouldn’t or should trade the cross currency pairs? Not at all. As majority of the FX market news on a daily basis focuses on the major economies, they are often ample of news and analysis available for each of the major currencies which means trading the crosses can be a great option for increasing your opportunity span.
However, having said that, the most important thing to always ask yourself before taking a trade is not whether it’s a major currency pair or whether it’s an exotic or a cross currency pair, but rather whether you have a valid fundamental or sentiment-based reason to actually enter that trade in the first place.
So, if the euro, for example, is the strongest currency due to a specific catalyst, and the pound is the weakest one on the day due to a specific catalyst, then trading the euro pound, which is a cross currency pair, might be the dominant sentiment for that particular session which will offer you the highest probability outcome compared to any of the other major currency pairs.
So, it’s not about whether a currency pair is a major or not, it’s about what the actual instrument that you’re trading, what it is, or what’s currently driving it, whether the market has a reason to buy the one currency and sell the other, and that of course will give you a much higher probability and heat trade with your trades as opposed to just looking at whether it’s a major or a cross or an exotic currency pair.
So, I hope that makes sense. As always, if there are any other questions, please feel free to let us know.