A cross-currency pair is a pair of two currencies that do not contain the US dollar (USD). The U.S. dollar might be the most liquid currency, but trading pairs that do not involve the USD can be an attractive option for investors.
A Look Back in History
A brief introduction to the history of cross currency pairs can reveal their importance for the markets and forex trading.
In 1944, during a World War II Allied Nations conference, the Bretton Woods agreement stipulated that all participating countries would have fixed exchange rates between their currencies and the U.S. dollar. That meant that a great number of currencies were pegged to the U.S. dollar, which was pegged to the gold standard.
Because of the agreement, people who wanted to exchange their currencies would first have to convert their money into U.S. dollars and then into their preferred currency. However, the Bretton Woods agreement was terminated in 1971. With the termination, the gold standard for the dollar ended and currencies around the world switched to a floating exchange rate which meant that the prices of their currencies would not be fixed and would be determined by supply and demand.
After the termination of the agreement, trades between cross-currency pairs became quite common. With only one spread crossed during the process, trades became easier and cheaper.
Trading Cross-Currency Pairs
As cross-currency pairs are not paired with the U.S. dollar, their rates can display greater fluctuation. When currencies from weaker economies are traded against currencies from stronger economies, there is potential for greater profits as well as greater losses.
Correlated Cross Pairs
Correlated cross-currency pairs include two currencies with high correlation. The pairs could either tend to move in the same direction and have a positive correlation or tend to move in the opposite or different direction and have a negative correlation. Trading handpicked correlated cross-currency pairs can be used as a risk management means of diversifying an investment portfolio.
The most highly correlated cross pairs comprise:
EURGBP
EURCHF
GBPCHF
AUDNZD
AUDCAD
NZDCAD
Uncorrelated Cross Pairs
These kinds of pairs include currencies that are uncorrelated and thus do not generally move in the same direction. Therefore, these pairs are highly volatile, and their exchange rate ranges can show great fluctuation within a single day. Trading uncorrelated cross pairs carry the potential for great profit but at the same time a higher level of risk.
The uncorrelated cross pairs group includes:
EURJPY
GBPJPY
EURNZD
EURAUD
EURCAD
GBPNZD
GBPAUD
GBPCAD
AUDJPY
NZDJPY
CADJPY
How to Trade Cross Currency Pairs
Cross-currency pairs trading can be used as a means to diversify a trading portfolio as you can gain exposure to currencies that do not involve the USD and therefore might not be affected by the same factors as the greenback.
When trading cross currency pairs, bear in mind that cross currencies might still correlate to the U.S. dollar indirectly. Financial and economic factors such as interest rate decisions, employment data, debt levels, commodity exposure, etc. can cause exchange rates to swing.
Test out your cross-currency trading strategies in a demo account and gain valuable experience before opening positions in a real account. If you have experience in trading the pairs that do not involve the USD, open your positions using Traders Trust’s unique promotions and maximize your trading potential.