The foreign exchange (forex) market is the largest and most liquid financial market in the world. It is a decentralized global marketplace where all currencies are traded against each other. Currency pairs, such as the US Dollar (USD) against the Euro (EUR), are at the core of forex trading. In this article, however, we will delve into cross currency pairs, a vital aspect of the forex market that allows traders to diversify their portfolios and unlock new trading opportunities. We’ll also explore the benefits of trading cross currency pairs with Zenita Finance, a leading forex broker.
What are Cross Currencies?
Cross currencies, also known as cross currency pairs or crosses, are currency pairs that do not involve the US Dollar. Traditionally, currencies were first converted into US Dollars and then into the target currency. Cross currency pairs bypass the need for such conversions, allowing traders to directly exchange one currency for another without going through the USD. This offers traders the opportunity to diversify their trading strategies and take advantage of fluctuations in other currencies.
Major Cross Currency Pairs
While there are numerous cross currency pairs in the forex market, the following are some of the most popular and widely traded:
- EUR/JPY: Euro against the Japanese Yen
- EUR/GBP: Euro against the British Pound
- EUR/CHF: Euro against the Swiss Franc
- GBP/JPY: British Pound against the Japanese Yen
- GBP/CHF: British Pound against the Swiss Franc
- AUD/JPY: Australian Dollar against the Japanese Yen
These major cross currency pairs often exhibit strong trading volumes and liquidity, making them appealing to forex traders.
Advantages of Trading Cross Currencies
Trading cross currencies comes with several advantages that can help traders optimize their strategies and achieve better results. Some of these advantages include:
Diversification
Cross currencies allow traders to diversify their portfolios by gaining exposure to different economies and monetary policies. This can help mitigate risk by spreading investments across various currencies, reducing the impact of adverse events in a single market.
Lower Trading Costs
Cross currency pairs often have tighter spreads than their major counterparts involving the US Dollar. Tighter spreads lead to lower trading costs, which can result in more profitable trades.
Unique Trading Opportunities
Cross currencies provide traders with unique opportunities to capitalize on economic and political events that may not directly affect the US Dollar. This can lead to profitable trading opportunities that may be overlooked by traders focused solely on major currency pairs.
Calculating Currency Cross Rates
Currency cross rates are the exchange rates of two currencies when neither involves the US Dollar. Calculating cross rates helps traders understand the relationship between two currencies without referring to the USD. Here’s a step-by-step guide on how to calculate currency cross rates:
Step 1: Obtain Exchange Rates
To calculate a cross rate, you’ll need the exchange rates for both currency pairs that involve the US Dollar. For example, let’s say we want to find the cross rate between the Euro (EUR) and the British Pound (GBP). We’ll need the exchange rates for EUR/USD and GBP/USD.
Suppose the current exchange rates are as follows:
EUR/USD: 1.2000
GBP/USD: 1.3500
Step 2: Determine the Base and Quote Currencies
In the forex market, currency pairs are quoted as base currency/quote currency. The base currency is the one being bought or sold, while the quote currency represents the amount of that currency needed to buy one unit of the base currency. In our example, we want to find the EUR/GBP cross rate, so the Euro is the base currency, and the British Pound is the quote currency.
Step 3: Calculate the Cross Rate
There are two possible methods to calculate the cross rate, depending on whether you need to multiply or divide the exchange rates.
Method 1: Division
If both exchange rates have the same base currency (e.g., EUR/USD and GBP/USD), divide the quote currency of the first pair (USD) by the quote currency of the second pair (USD) to get the cross rate.
EUR/GBP = EUR/USD ÷ GBP/USD
In our example:
EUR/GBP = 1.2000 ÷ 1.3500
EUR/GBP = 0.8889 (rounded to four decimal places)
So, the EUR/GBP cross rate is 0.8889, meaning it takes 0.8889 GBP to buy 1 EUR.
Method 2: Multiplication
If both exchange rates have the same currency (e.g., USD/EUR and USD/GBP), multiply the base currency of the first pair (USD) by the base currency of the second pair (USD) to get the cross rate.
EUR/GBP = USD/EUR × USD/GBP
In our example, we need to first invert the given exchange rates:
USD/EUR = 1 ÷ 1.2000 = 0.8333 (rounded to four decimal places)
USD/GBP = 1 ÷ 1.3500 = 0.7407 (rounded to four decimal places)
Now, we can calculate the cross rate:
EUR/GBP = 0.8333 × 0.7407
EUR/GBP = 0.6168 (rounded to four decimal places)
However, this result is the inverse of the actual EUR/GBP cross rate. So, we need to invert it again:
EUR/GBP = 1 ÷ 0.6168 = 1.6209 (rounded to four decimal places)
Thus, the EUR/GBP cross rate is 1.6209, meaning it takes 1.6209 GBP to buy 1 EUR.
Keep in mind that exchange rates fluctuate constantly, so the calculated cross rates may differ from the real market rates at any given moment.
Cross Currency Volatility and Liquidity
Cross currency volatility and liquidity are crucial factors for forex traders to consider when selecting which pairs to trade. Both can significantly impact trading strategies and profitability.
Volatility
Cross currency pairs can exhibit varying levels of volatility based on the economic and political conditions of the countries involved. High volatility can offer greater profit potential, but also increases the risk of losses. Traders should assess their risk tolerance and adjust their strategies accordingly.
Liquidity
Liquidity refers to the ease with which a currency pair can be bought or sold without causing significant price fluctuations. Highly liquid cross currency pairs, such as EUR/JPY or EUR/GBP, often have tight spreads and rapid execution speeds. This can lead to lower trading costs and more predictable price movements.
The Role of Cross Currencies in Global Trade
Cross currencies play a crucial role in global trade by enabling businesses and individuals to transact directly in their local currencies without converting to the US Dollar. This facilitates international trade by reducing transaction costs, promoting currency diversification, and simplifying the exchange process.
Reduced Transaction Costs
By eliminating the need to convert through the US Dollar, cross currency transactions reduce the overall costs associated with currency conversion. This directly benefits businesses and consumers engaged in international trade.
Currency Diversification
Cross currencies allow market participants to diversify their currency exposure, mitigating risks associated with fluctuations in a single currency. This diversification strengthens the global economy by spreading risk across multiple currencies.
Simplified Exchange Process
Cross currencies simplify the currency exchange process by allowing direct conversion between two non-USD currencies. This streamlines international transactions and makes it easier for businesses and individuals to engage in global trade.
Cross Currency Trading Strategies
Cross currency trading strategies can help traders diversify their portfolios, capitalize on unique market opportunities, and manage risks more effectively. Here are three popular strategies specifically tailored for cross currency pairs:
Carry Trade
The carry trade strategy involves borrowing in a currency with a low-interest rate and investing in a currency with a higher interest rate. The trader profits from the interest rate differential between the two currencies. Carry trades are suitable for cross currency pairs with significant interest rate disparities, such as AUD/JPY or NZD/JPY.
Mean Reversion
Mean reversion is based on the idea that currency pairs tend to revert in the long run toward their historical averages. Traders can identify overbought or oversold cross currency pairs using technical indicators, such as Bollinger Bands or the Relative Strength Index (RSI), and then take positions that anticipate a return to the average price level.
Momentum Trading
Momentum trading strategies capitalize on existing market trends by identifying cross currency pairs with strong directional movements. Traders can use trend-following indicators, such as moving averages or the MACD, to determine entry and exit points that align with the current trend.
Tips for Trading Cross Currencies
To help you succeed in cross currency trading, we’ve compiled a list of tips to consider:
Do Your Research
Before trading any cross currency pair, it’s crucial to research and understand the factors that influence the currencies involved. This includes economic indicators, political events, and central bank policies. Having a thorough understanding of these factors can help you make more informed trading decisions.
Use Technical Analysis
Technical analysis is an essential tool for identifying trading opportunities in cross currency pairs. By analyzing historical price data, traders can identify patterns and trends that may signal future price movements. Zenita Finance’s advanced trading platform offers a variety of technical analysis tools to help you spot potential opportunities.
Employ Risk Management Strategies
Risk management is a critical aspect of forex trading, especially when dealing with cross currency pairs. To minimize the impact of market volatility, traders should utilize stop-loss orders, position sizing, and diversification in their trading strategies.
Be Mindful of Correlations
Currency pairs can exhibit correlations, meaning that they move in tandem or opposite directions. It’s essential to be aware of these correlations when trading cross currencies, as they can impact the overall risk exposure of your portfolio. Zenita Finance’s trading platform allows you to monitor currency correlations in real-time, helping you make better-informed trading decisions.
Conclusion
Cross currencies in the forex market present traders with unique opportunities to diversify their portfolios and capitalize on market movements that may not involve the US Dollar. By trading cross currency pairs with Zenita Finance, traders can take advantage of our advanced trading platform, competitive pricing, expert market analysis, and superior customer support. Incorporating cross currencies into your trading strategy can help you unlock new trading opportunities and achieve better results in the ever-evolving forex market. Join our Telegram channel for more information and updates on promotions, and the latest forex market news.