Forex trading uses a wide range of specialist terminology. Once such term is ‘currency cross pairs’. But what are currency cross pairs – and why do they matter to traders? This article will explore the concept in detail.
Let’s start with a definition. Currency cross pairs are simply currency pairs that do not contain the US dollar (USD). An example of a cross pair would be GBPJPY or EURCHF. There are numerous cross pairs available. Which ones you can trade depend on your chosen broker.
Keep in mind, the most commonly traded currency pairs in Forex all contain USD. In fact, it’s estimated that over three-quarters of all Forex trades contain USD.
Furthermore, the Forex market is dominated by pairings of major currencies. These are sometimes called ‘major currency pairs’. While there is no official list of the world’s most traded major pairs, the vast majority of Forex participants agree upon these seven:
- US Dollar/Swiss Franc (USDCHF)
- Australian Dollar/US Dollar (AUDUSD)
- US Dollar/Canadian Dollar (USDCAD)
- Euro/US Dollar (EURUSD)
- Great British Pound/US Dollar (GBPUSD)
- US Dollar/Japanese Yen (USDJPY)
- And finally; New Zealand Dollar/US Dollar (NZDUSD)
The importance of USD
The US dollar (USD) is the world’s most popular currency. It’s a reflection of the economic strength of the United States of America.
Many global commodities – including oil, gas and agricultural goods – are priced in US dollars. For this reason, USD is known as the world’s reserve currency. It’s why many foreign central banks keep reserves of USD.
There are also a number of countries who use the US dollar as their currency. Examples include Ecuador and El Salvador – these are both countries that have adopted USD.
So it’s clear that USD is integral to the world’s economy. Its liquidity used to mean that all other currencies would have to be converted into US dollars before being traded. So if you wanted to convert British pounds into Canadian dollars, you would need to follow this process:
- Convert British pounds into US dollars
- Convert US dollars into Canadian dollars
Technology has now changed this process. Traders now have the ability to trade currencies without involving USD.
But why would a trader want to do this? Let’s explore this in further detail in the next section.
Exploring currency cross pairs
Most traders only trade the major currency pairs (listed above). They do this because these pairs are very liquid (making them cheaper to trade) and because they are easier to analyse. Consider the coverage of 24/7 financial news outlets – their focus is heavily skewed in favour of the major economies. With this kind of attention, it’s easier for traders to analyse the major pairs.
But there is one limitation when traders exclusively trade major pairs. Namely, every trade they place is essentially speculating on the price of USD. Think about it. If you have two open positions on GBPUSD and EURUSD – both are dictated by the future strength of USD. It’s a relatively narrow focus for analysis.
This is why some traders believe in trading currency cross pairs. By eliminating USD from their position, they can broaden the scope of their analysis and speculate on the direct relationship between other pairs.
Limitations of currency cross pairs
It’s true that cross currency pairs can present more trading opportunities. But this isn’t necessarily a good thing.
Firstly, cross pairs tend to be more expensive to trade than major pairs. This is because the liquidity of USD makes major currency pairs cheaper to access. Remember, the fewer traders there are in a market, the harder it is to get your trade filled. This in turn can cause the cost of trading to go up.
Secondly, volatility on cross pairs tends to be less predictable than on major pairs. This is because USD is a relatively stable currency which anchors the moves of major pairs within manageable ranges.
It’s also because fewer people trade currency cross pairs. This means that when a large order is placed on a cross pair, it causes a much bigger price move than it would on the related major pair. The extra expense and potential volatility can make cross pairs more difficult to profit from.
The most stable cross pairs to trade are those made up from the seven major currencies (excluding USD):
- Canadian Dollar (CAD)
- Great British Pound (GBP)
- Swiss Franc (CHF)
- Euro (EUR)
- Japanese Yen (JPY)
- Australian Dollar (AUD)
- New Zealand Dollar (NZD)
Again, this is because these currencies are extremely liquid.
Currency cross pairs of minor currencies are even more volatile and expensive to trade. Many traders label these pairs as ‘exotics’. These pairs can be notoriously difficult to trade.
What are currency cross pairs?
I recommend that you focus on trading combinations of the major currencies – which can include currency cross pairs. This is for two reasons.
Trading major currencies is cheaper and less volatile. This is because of their liquidity.
You will find conducting fundamental analysis on major currencies easier to conduct. This is because the financial news media skews its analysis and coverage in favour of the major economies.
I hope you’ve found this article useful. If you have any questions, please leave them in the comments below. I’ll do my best to reply to as many as I can.