Exploring Cross Currency Trading In Forex
Cross currency pairs, also known as minor currency pairs, are pairs that do not include the US dollar, but include at least one of the other three major currencies of the world.
As major world economies become more globalized, and dependency on the US dollar seems to slowly but gradually deteriorate, traders may look to a more diverse range of currency pairs to invest in which don’t involve the dollar. Cross currency pairs provide the Forex market with the means to exchange currencies without having to fall back on the U.S. dollar as a settlement currency. In this article I’ll be looking at what a cross currency pair is, the benefits and challenges of trading cross currencies, how to calculate the exchange rate for a cross currency pair, and various strategies for trading cross currency pairs.
What is a cross currency pair?
A cross currency pair in Forex refers to any currency pair that does not involve the U.S. dollar. Most exchanges of currency in the world use the U.S. dollar as a contract settlement currency. Since World War II, most currencies have been pegged to and quoted against the dollar. Historically, to make transactions between non-U.S. currencies, individuals would be required to first exchange into dollars, and then into the second currency. Today, although the dollar still acts as the world’s reserve currency, the Forex market allows exchanges to be made between currencies without using the dollar.
When we talk about currency pairs in Forex, we distinguish between the three types: major pairs, minor pairs, and exotic pairs. Some people may refer to minor pairs as ‘cross pairs’, but this is not always correct. There is often confusion between minor pairs and cross pairs, although there is an important but easy-to-miss distinction between the two.
A major pair is defined as any currency pair involving USD and another major currency. A minor pair is a pairing of any two major currencies that aren’t the U.S. dollar. An exotic pair is a combination of a major currency pair (including USD) with an exotic currency. These are the three distinct categories of currency pairs.
A cross currency pair on the other hand, is simply any combination of major or minor currencies that are not the U.S. dollar. That means that all minor pairs are cross currency pairs, but so are some exotic pairs. An exotic pair falls under the classification of ‘cross currency pair’ if it doesn’t involve the U.S. dollar.
Advantages and challenges of trading cross currencies
As the U.S. dollar is the world’s reserve currency, and the most traded currency on Earth, any pairing involving USD consequently has more liquidity and stability when compared to cross currency pairs. In fact, the top six most traded currency pairs in the world all feature the U.S. dollar. However, this does not mean that cross currency pairs don’t have their own advantages. Let’s look at some of the advantages and disadvantages of trading cross currencies:
👍 Pros
• 1. Diversification: Trading cross currencies allows you to diversify your portfolio and exposes you to different economies without needing to involve the U.S. dollar
• 2. Reduced Dependency on USD: Trading cross currency pairs that don’t feature USD is beneficial in situations where the USD is exhibiting a particular negative trend, or where traders want to avoid the influence of U.S. economic factors
• 3. Wider Economic Insights: When you trade cross currencies, you develop a wider understanding of the world economy and gain insight into the economic conditions of the countries represented by the pair. This can be a great learning experience for traders who hope to be more involved in a globalized economy
• 4. Specialized Trading Strategies: Cross currency pairs offer unique trading opportunities and trends that may not be seen when trading in USD pairs. This allows traders to develop specialized strategies based on the characteristics of the currencies involved
👎 Cons
• 1. Less Liquidity: Cross currency pairs tend to have lower liquidity compared to major currency pairs, which can result in a wider bid-ask range. This can make it slightly more costly to trade them
• 2. Higher Volatility: Many cross currency pairs exhibit higher volatility than major pairs, which can lead to more significant and sudden price movements. While this volatility presents trading opportunities, it also increases the risk of unforeseen losses
• 3. Limited Information: Most business or finance news is generally centralized around the U.S.A, so it may be challenging to access timely and comprehensive information for making informed decisions about cross currency pairs
The types of currency pairs that you trade in will ultimately depend on your own strategies and your financial goals. Though there are some advantages to trading cross currency pairs, there are also challenges. If you’d rather trade major currency pairs, see our article about the best major currency pairs.
How do I calculate the exchange rate for a cross currency pair?
When trading cross currency pairs, it’s important that you first calculate the exchange rate. Despite cross currency pairs not involving the U.S. dollar, we can still refer to USD for the foundation of our calculation. This may seem complicated to a novice trader, so let’s break down the process.
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First, you need to understand the base and quote currencies. In a pairing XXX/YYY, the base currency is the first one in the pair (XXX) and the quote currency is second (YYY). Let’s use EUR/GBP as an example, where EUR is the base currency and GBP is the quote currency
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Next, find the exchange rates for both currencies against a common currency. We’ll use the U.S. dollar (USD). So, EUR/USD is 1.06, meaning 1 Euro is worth $1.06 USD. GBP/USD is 1.22, meaning 1 GBP is $1.22 USD
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Then we need to calculate the cross rate by dividing the exchange rate of the base currency by the exchange rate of the quote currency. The cross rate therefore is the EUR/USD rate divided by the rate of GBP/USD, or EUR/GBP. This is 1.06 divided by 1.22
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Finally, we can determine the cross rate as 0.8688. So, in this example, the exchange rate for EUR/GBP is approximately 0.8688. This means that 1 euro is equivalent to 0.8615 British pounds
You can calculate the cross rate of a cross currency pair using another common currency as an intermediary too. Just substitute the USD in this example for another major currency and follow the same steps. To better understand currency pairs and how to trade them, see this article.
Trading strategies for cross currency pairs
As we explored above, trading cross currency pairs offers unique opportunities but also comes with its own challenges. There are strategies and techniques you can adopt in order to maximize your success while trading cross currency pairs:
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Understand the economic relationships involved
Analyze and attempt to understand the unique relationships between the two nations of the currency pair you are trading. For example, if trading EUR/GBP, learn about how the European Central Bank and Bank of England influence exchange rates and price action -
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Analyze correlations between major pairs
Look at the correlation between your cross currency pairs and related major pairs. For example, if trading EUR/GBP, compare its movement to that of EUR/USD and USD/GBP. Understanding how these currencies move in relation to each other can help in risk management and position sizing -
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Adjust risk management for Increased volatility
Cross currency pairs often exhibit higher levels of volatility than major pairs. Adjust your risk management strategy accordingly, by setting wider ranges for your stop-loss and take-profit orders -
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Avoid markets with low liquidity
Cross currency pairs include a lot of exotic pairs that have lower liquidity. Focus on pairs with higher liquidity, preferably featuring major currencies -
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News and events
Stay informed about economic news and events related to the countries in your chosen cross currency pairs. Central bank announcements, economic data releases, and geopolitical developments can lead to significant price movements
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FAQs
Why are cross currency pairs also called "minor" pairs?
All minor pairs are cross currency pairs, and feature major currencies that are not the U.S. dollar. It’s important to note that not all cross-currency pairs are minor pairs though, as some cross currency pairs are also exotic pairs.
Are cross currency pairs good for beginners?
Some of them are. Cross currency pairs featuring major currencies have moderate liquidity and are stable enough for beginners to trade. However, some cross currency pairs are exotic pairs with low liquidity, and therefore not ideal for beginners.
What are some commonly traded cross currency pairs?
The most popular cross currency pairs are EUR/GBP, EUR/JPY, GBP/JPY and AUD/JPY.
What should traders be cautious about when trading cross currency pairs?
Be aware of the lower liquidity and increased volatility compared to major pairs. Also pay attention to trading volume as some cross currency pairs will be traded significantly less than others, which will impact results.
Team that worked on the article
Jason Law is a freelance writer and journalist and a Traders Union website contributor. While his main areas of expertise are currently finance and investing, he’s also a generalist writer covering news, current events, and travel.
Jason’s experience includes being an editor for South24 News and writing for the Vietnam Times newspaper. He is also an avid investor and an active stock and cryptocurrency trader with several years of experience.
Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.
The topics he covers include trading signals, cryptocurrencies, Forex brokers, stock brokers, expert advisors, binary options. He has also worked on the ratings of brokers and many other materials.
Dr. BJ Johnson’s motto: It always seems impossible until it’s done. You can do it.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO). Mirjan is a cryptocurrency and stock trader. This deep understanding of the finance sector allows her to create informative and engaging content that helps readers easily navigate the complexities of the crypto world.