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What are Cross Currency Pairs?
The global forex market involves buying and selling the currencies of major economies. These are also called major currency pairs and form the bulk of trading volume in the market. The major currency pairs involve the U.S. dollar, the world's reserve currency for decades. But not all pairs have to involve the U.S. dollar. In fact, some of the most tradable—although regional—minors do not involve the dollar at all. This blog is for traders who want to learn more about what are cross currency pairs.
Published on 24 July 2024
How Does Cross Currency Pairs Work?
Cross currency pairs are called "crosses," "cross rates," or the trading of two major currencies where the U.S. dollar is not an intermediate step. In other words, these two very important currencies exchange between themselves directly, not with the intermediation of the U.S. dollar. Such pairs are typically relevant to specific regions and very popular to trade among people living in the respective countries represented by each of these two currencies. For example, AUD/NZD is a cross currency pair that is most important to traders living in both Australia and New Zealand.
We can look at a step-by-step example to better understand how cross-currency pairs work.
Regional Significance
Cross-currency pairs can be used to indicate regional trade and investment flows. In fact, very often, traders and investors look at these pairs as influenced by trade agreements, tariffs, and economic policies on financial markets. For instance, the AUD/NZD pair indicates trade and economic relations between Australia and New Zealand.
Volatility
Volatility is an important factor in relation to cross-currency pairs. The volatility of cross-currency pairs varies depending on the specific currencies involved. Currency pairs with strong economic ties or similar interest rate policies may also exhibit lower volatility. Cross-currency pairs are almost always of lower trading volumes and correspondingly lower liquidity relative to major pairs. The lower liquidity tends to reflect on wider spreads and significantly high price gaps, which perhaps lead to higher volatility over a couple of trading sessions.
Cross-currency pairs can be more sensitive to news and events related to the countries in which the currencies are involved. All factors—major economic data releases, political developments, and geopolitical events—can affect cross-currency pairs more sharply and hence translate into higher volatility in their exchange rates.
ATR (Average True Range)
The Average True Range, or ATR, measures the average price range over a specified period and is often lower for cross-currency pairs than for major pairs. This lower ATR can represent less intraday price movement and reduced volatility. ATR is an important indicator in forex trading, and cross-currency pairs are typically characterized by lower ATR values.
Less Market Influence
Major currency pairs, especially those involving the USD, often have a direct impact on other currency markets. In contrast, cross-currency pairs may be influenced more by the specific economies of the countries in the pair, making their movements less predictable. For example, the AUD/NZD exchange rate may only be significant for bilateral trade between Australia and New Zealand but not for the world economic performance.
Benefits of Trading in Cross-currency Pairs
Cross-currency pairs present multiple trading opportunities, and here are the reasons why they can be a beneficial addition to your trading strategy:
1. Trade Without Being Tied to the US Dollar
When you trade currency pairs linked to the US dollar, you are limited to a single prediction of whether the US dollar might go up or down. However, you can consider other factors with cross currency pairs that are not affected by the US dollar and explore more trading opportunities. Cross-currency pairs can also be a part of your go-to trading strategy if you need to wait out volatile trading conditions with the US dollar.
2. Diversify Your Portfolio
Trading different instruments helps keep your portfolio varied and may increase your chances of enhanced potential profit. Other than that, you also get to trade the currency pairs that are sensitive to the prices of movement in the commodities market for the mere fact that these countries produce and export various goods and services. Note, however, that this strategy depends on full research into the political, social, and economic factors which influence these trends.
3. Hedging in Forex
In other words, it is a strategy in which one secures his trade if the market does not move in his favor by placing an opposite trade as well. You can spread the risk by trading different cross-currency pairs to secure yourself from the volatility of cross-currency rates.
4. Increase Trading Volume During Particular World Events
This is an opportunity that has not been previously given to you, and turning world events into capital which isn't based upon the US dollar has previously required that you commission two separate trades: for instance, a euro-to-pound sterling trade would require you to pay transaction fees for a EUR/USD trade, and then another one for a GBP/USD trade. But with cross-currency pairs, you can actually place a trade directly on the currency – EUR/GBP. So, instead of being used for transaction fees for several trades, your capital can be used to increase your trade volume.
Risks of Trading in Cross-currency Pairs
Here are some of the risks associated with the trading of the cross currency pairs:
- Cross-currency pairs usually have reduced trading volumes and liquidity than major currency pairs, resulting in wider spreads, increased slippage, and reduced ease of execution.
- Due to lower liquidity, trading costs may be higher when trading cross-currency pairs, as brokers often charge higher spreads and commissions for these pairs.
- These pairs are fluctuating because of their decreased liquidity and sensitivity to regional economic news and events. This volatility may result in unpredictable price movements and increased risk.
Key Takeaways
Cross currency pairs do not include the U.S. dollar. These pairs have regional significance and largely depend on the trade relations between the issuing countries. During low liquidity, the cross pairs tend to be very volatile compared to the major currency pairs and are thus traded with low volatility. The traders and investors investigate relations between regions with respect to pairs, the dynamics of trade, geopolitics, and monetary policies that are going to shape the forex market. The Espresso has made trading currency pairs in India easy and convenient for traders like you.
