How to trade cross currency pairs - Grand Forex Systems


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How to trade cross currency pairs

 Successful trading of major forex currency pairs lies in the trader's correct determination of these currencies' strength or weakness about the US dollar. As a rule, the bullish or bearish sentiments for the US dollar, which is the main global reserve currency, determine movement in these currency pairs. Almost all the main industrial, agricultural, and global strategic resources are estimated in US dollars and, despite the crisis, today the US economy is the largest in the world.

Thus, most of the speculative transactions are directly related to the purchase or sale of dollars. This situation reduces the trader's opportunities. To expand trading opportunities, currency cross rates are increasingly used in trading.

What is Forex Cross Rate?

The cross rate is the exchange rate ratio between two currencies, calculated based on each of the currencies in the pair about the third currency. In the FOREX market, the cross rate is considered a currency pair without the US dollar's participation. 

 When trading cross currency pairs, one currency is valued in terms of the other currency, not US dollars. The cross rates calculation is linked to the exchange rates of each currency in the pair against USD. So, the EUR / JPY cross rate is the result of multiplying EUR / USD and USD / JPY: EUR / JPY rate = (EUR / USD) * (USD / JPY).

 Cross rates are often used in a carry trade strategy. The strategy aims to sell a currency with a low interest rate and buy a currency with a relatively higher interest rate, making a profit on the interest difference. Japan is a country with meager interest rates. Therefore, the Japanese yen is the main currency of this strategy and is traded against major currencies with a higher interest rate, providing investors income. Currently, in the global financial crisis and falling interest rates for all major currencies, this strategy practically does not work.

What a novice trader needs to know when trading cross currency pairs

The main feature of cross rates is their high volatility. This quality makes them attractive for trading, allowing you to make good profits, but it should not be forgotten that the same quality can cause significant and rapid losses.

 The most highly volatile crosses include the following currency pairs: GBP / JPY, EUR / JPY, CHF / JPY, AUD / JPY, CAD / JPY, NZD / JPY, GBP / CHF, EUR / AUD, EUR / CAD, AUD / CAD, AUD / NZD

 As an exception, the EUR / CHF and EUR / GBP pairs are low volatility. This is because there is a strong direct relationship between EUR / USD and GBP / USD and a strong inverse relationship between EUR / USD and USD / CHF (the charts of these pairs are almost mirrored).

The most popular and frequently used are “yen crosses” - GBP / JPY, EUR / JPY, AUD / JPY, CAD / JPY, NZD / JPY.

Most of the movements in the yen occur relatively synchronously across different currency pairs. Synchronicity can only be broken when macroeconomic indicators are released from other countries. 

 Thus, the “negative” for the UK may cause a fall in the GBP / JPY pair, but these events will not affect EUR / JPY, AUD / JPY, CAD / JPY, NZD / JPY. The GBP / JPY cross rate is the most volatile and can pass several hundred points one day.

 When trading cross rates, given their volatility, the accuracy of entering a trading position is essential. For this purpose, it is recommended to use small M15 timeframes and even 5-minute to open a position.

 It should be remembered that if the major currency pairs make random oscillatory movements of 30-50 pips (trading noise) before the trading direction is determined, then for currency crosses, especially yen, this value can be 100-150 points. The JPY can accidentally move 150 pips against your position before turning around and going in your direction, and these moves can occur in a matter of seconds. The same volatility and speed of movement, with accurate entries, can allow you to make significant profits in a short period of time.

 Trading cross rates, except for technical analysis, is unthinkable without taking into account the fundamental background in world markets; that is, when assessing the possibility of entering a deal, it is necessary to understand the driving forces of each of the currencies, and it is largely determined by the state of the economies of the countries of these currencies. 

 Therefore, you should study the stock markets' major indices, the US, Europe, Asian markets.

 Technical analysis of cross-rates has no peculiarities; it is important to clearly define support and resistance zones on higher timeframes (daily, four-hour). Reversal patterns (double, triple tops, head and shoulders) and continuation patterns work well. During the technical analysis, it is obligatory to consider the trends of higher time intervals, and it is better to identify trading signals on smaller timeframes.

 Accordingly, stop-loss should be larger than on the main currency pairs, but one should not forget about the principles of money management and the size of positions opened. Do not forget that the risk in each transaction should not exceed 2% of the deposit.

 Some currency cross rates, especially EUR / CHF, EUR / GBP, are quite complex crosses due to the complexity of interpretation and understanding of the impact of economic indicators of the Eurozone, Switzerland, Great Britain on the movement of currencies and are not recommended for novice traders. Despite their slow movement and low volatility, making a profit on them is quite difficult. Sometimes there is almost no movement and you have to leave the cross for a long period of time, especially when there is a small loss, exposing the position to unnecessary risk.

 There are other, more exotic pairs, for example, AUD / CAD, AUD / NZD, and several even rarer ones, which are quite difficult to understand the driving forces of these currency pairs and are also not recommended for novice traders.

 It should be emphasized the importance of tracking yen crosses to forecast the movement of major currency pairs. Strange as it may seem, but often movements along these cross-rates can be leading and forerunners of movement in major currency pairs. 

 Very often, the GBP / USD rate follows the GBP / JPY. GBP / JPY started to grow and with a small time lag GBP / USD, with a fall - the same thing. To determine the synchronization and identify the leading pair, it is enough to observe the movement simultaneously in some open windows or overlay the movement charts on top of each other using the indicator. 

 With certain skills, you will detect earlier trading signals on the cross and use this to trade on the main currency pair. The cross's movement began earlier and with a slight delay, you can expect movement in the main currency pair.

 The same can be attributed to the EUR / USD pair, the movement of which can be determined and predicted by strong movements of the EUR / JPY pair, especially if significant technical levels are broken on the EUR / JPY chart, as determined on large time charts (four-hour, daily). A breakout of such significant levels may signal a reversal of the EUR / USD pair.

 It must be remembered that all cross-currency pairs have their own distinctive characteristics, dependence on various political events and economic news, their own interest rate, which often set certain movements for these currency pairs.

 In conclusion, it must be said that before starting trading on cross-rates, a novice trader needs to study the nature of the movement and behavior of the cross on demo accounts, get used to its volatility, study its reaction to the release of fundamental data, the relationship with stock market indices and then add one pair to your arsenal of trading instruments.