Currency Crosses

After going through the School of Pipsology and doing a little demo trading, there’s probably one thing you’ve noticed about trading currencies – it’s all about the US Dollar! Or is it?
Well, with central banks across the world holding trillions in USD reserves, commodities priced in the Greenback, and other major financial transactions passing through the dollar daily, it pretty much IS all about the dollar. 

In general, approximately 90% of all transactions in the almost US$2 trillion daily traded Foreign Exchange market involves the dollar. Wow!
Also, in your demo trading, I’m sure you’ve noticed that no matter what major pair you trade (i.e. EURUSD, AUDUSD, USDCHF, etc.) that US news pretty much dominates the movement regardless of data releases from anywhere else. So, why look at anything else besides the major currency pairs?

Well, serious trading opportunities can be found by following the other major currencies with currency crosses, especially if you want to avoid the unpredictable volatility that US dollar can bring.
Hopefully, this lesson will open up your outlook on Crosses and give you basic understanding on how to analyze them.

What is a Currency-Cross?
Basically, a currency-cross is any currency pair in which the US Dollar is neither the base nor counter currency. For example, GBPJPY, EURJPY, EURCAD, and AUDNZD are all considered currency crosses.

Back to Basics
When it comes down to it, currency trading is all about matching weak currencies and strong currencies.
Just find a country that has weak a fundamental outlook or maybe a distressful political situation, and then match it with a country with positive or better fundamentals (i.e. rising employment, growing trade surplus, etc) or maybe a positive political outlook, then you can match their currencies together to make an intelligent directional trade.

Let’s take a look at a recent, real world example:
On January 11th, 2007, both the Bank of England and the European Central Bank were set to release their decisions on their interest rate policy. Leading up to that morning, the markets speculated that the ECB hint that they would raise interest rates soon and the BoE would hold any hikes. Well, what a surprise the market got as the Bank of England raised rates to 5.25% and the ECB held rates at 3.50% on concerns of slowing growth in the Eurozone.
So, why would a currency trading pro, such as yourself, play a currency cross instead of matching either the Euro or the British Pound with the US Dollar? Well, here are a couple of scenarios to think about:
  1. US Retail sales numbers were coming out soon after the interest rate decisions. If you had a weak outlook on the Euro and went short EURUSD, then a weak US Retail report would probably been bad for your trade as the US dollar would sell off.
  2. Or if you maintained a strong outlook on the British Pound and decided to go long GBPUSD, then a dollar rally on a strong US retail sales report would have been very bad for you trade.
After the interest rate releases, we know the outlook on the Euro is weaker and the outlook of the British Pound is stronger, why don’t we just short EURGBP? By taking this trade you get rid of the event risk of upcoming US data, plus you get a positive carry on your position!
Here’s how you may have faired taking a short trade on EURGBP using this analysis:

As you can see from the chart, had you shorted at 0.6650 an hour or so after the interest rate decisions were announced, you would have caught the slow and steady move to 0.6600, and possibly further until fundamentals change for either the Euro or the Pound.
Again, this is just one example of matching weak with relatively stronger currencies. With six major currencies other than the US dollar, there are plenty of possibilities to find profitable trades, and avoid erratic volatility with the US dollar.

Synthetic Pairs
You’ve done your analysis and you’ve come to the conclusion that the British Pound looks strong and the Swiss Franc may get weaker.
Or maybe the Australian dollar is looking pretty good against the Canadian dollar, but you look in your trading platform and see that your broker doesn’t have GBPCHF or AUDCAD.
Oh no! I guess that’s an opportunity missed, right? Heck No! You can create a “synthetic” pair to go long on GBPCHF or AUDCAD.

To create synthetic pairs using the four major currency pairs and three commodity currencies is relatively easy. All it takes is to buy or sell two pairs with equal position sizes.
Let’s say you want to go long the British Pound against the Swiss Franc, or buy GBPCHF.
You would have to buy GBPUSD and buy USDCHF at the same time. Still not clear? Let me show you…

Pretty simple, right? The only trick to it is making sure you buy the same amount of each pair.
Using our GBPCHF example, let’s say the current exchange rate for GBPUSD is 1.9000 and the exchange rate for USDCHF is 1.2500 and you want to buy US$10,000 worth of each pair. Here’s how you do it:

For pairs with USD as the counter currency (i.e. AUDUSD, GBPUSD, EURUSD, etc.), then you would take the dollar amount you want to purchase and divide it by the exchange rate:
US$10,000 (desired position size) divided by 1.9000 (current rate of GBPUSD) = 5263 Units of GBPUSD

For pairs with USD as the base currency (i.e. USDCHF, USDJPY, USDCAD), just purchase amount of units you want to buy because you are buying US dollars
$10,000 (desired position size) * 1 Unit = 10,000 Units
So, to buy US$10,000 worth of GBPCHF, we purchase 5,263 units of GBPUSD (if your broker doesn’t offer flexible lot sizes you can always round up or down) and 10,000 units of USDCHF. Got it? Great! I knew you would!

As you can see, there are many, many trade opportunities presenting themselves in the foreign exchange market other than figuring out what the Greenback will do any given day - and now you know how to find them! Just remember a few things:
  • Do your due diligence/analysis and match the weak currencies with strong currencies.
  • What if the pair you are looking to trade is not available with your broker, no sweat right? You now know how to create synthetic pairs by simultaneously going long or short two major pairs to create one currency cross.
  • Last tip; please be conscientious of the pip value of the cross you are trading. For example, a standard lot (100,000 units) of EUR/GBP will be approximately $19.70 per pip. Some crosses will have a higher or lower pip value than the majors. This information is good to know for your risk analysis.
So, on the days you many not see any opportunities in the major pairs, or if you want to avoid the volatility of a US news event, check out some the currency crosses. You may never know what you may find! Good luck!