Cross currency pairs involve a pair of currencies neither of which is the US dollar. The term is used to refer to the trading of one currency for another without having to first convert the currencies into the US dollar, implying that a direct exchange between the two is possible. Cross currency pairs are less noticeable in forex trading since the US dollar is the highest trading currency in the forex markets. The rates at which these currencies trade, are called cross rates.
In the past, whenever a currency had to be exchanged for another currency, the former would first have to be converted into its dollar value and then convert the dollar amount into the desired currency. The concept of cross currencies helps to save one conversion, with a direct exchange possible. An example of cross currencies is the British Pound / Japanese Yen, which initially required that the yen be converted in to US dollars, and would then get converted into pounds. However, as cross currencies a direct conversion takes place.
Currency pairs that involve the Euro like the EUR/GBP are called euro crosses. Other euro crosses include the Euro-Japanese Yen pair referred to as EUR/JPY, the Euro-Swiss Francs pair, called EUR/CHF, the Euro-Australian dollar pair called the EUR/AUD, and the euro-New Zealand dollar or EUR/NZD. Currencies from developing countries have also started being used in forex trading.
Another type of cross currency pairs includes those which have neither the USD nor the Euro. Examples of these include the Singapore dollar-Malaysian Ringgit called MYR/SGD, and the Thai Baht-Singapore Dollar pair called SGD/THB.
Benefits offered by Cross Currency Pairs
Cross currency pairs are a big boon for forex trading since it saves the hassles involved in multiple conversions. Additionally they provide multiple benefits, some of which are listed below:
- Cross currency pairs help to diversify the trading portfolio, since they offer additional options for forex trading.
- Facilitate taking advantage of interest rate disparities.
- Prices in cross currency pairs have a different volatility than pairs with US dollars. This makes cross currency pairs a safer choice for forex trading by newcomers.
- Cross currency pairs have a higher earning potential in trading.
- Indicate the relative strength of the US dollar, vis-à-vis the currencies in question.
- Trends and ranges in cross currencies are clearer than on major currency pairs.
- Cross currencies often have an impact on major currency prices.
Drawbacks
- Cross currency pairs offer less safety and security in trading.
- Since cross currency pairs often involve currencies from developing countries, there is a higher element of risk.
- Trading is difficult since the number of people interested in cross currency pairs is very limited.
- Cross currencies are exposed to a wider spread than other currency pairs.
The best strategy to trade in cross currencies involves the use of the same fundamental and technical analysis. Cross currencies offer an alternative to forex traders when they wish to steer clear of trading in major currency pairs involving the US dollar.
