Cross currency trading refers to forex transactions that do not include the US dollar (USD).
A cross rate refers to a currency pair that excludes the US dollar. An example of a cross rate is GBP/JPY,
in which the two currencies being traded are the British Pound and Japanese Yen.
How Does Cross Currency Trading Work?
Historically, forex transactions had to involve the US dollar. When two non-USD currencies had to be traded,
the trader was required to first convert the currency he/she was holding into US dollars and then convert US dollars into the
desired currency. Cross currency trading bypasses this step.
There are two types of Cross Currency pairs. These are:
1. Pairs involving the Euro as the reference currency, such as Euro/Japanese Yen (EUR/JPY), Euro/Swiss Francs (EUR/CHF) and Euro/British Pound (EUR/GBP). Cross rates that involve the Euro are known as Euro crosses.
2. Pairs that involve neither the Euro nor the US dollar, such as Malaysian Riggit/Singapore Dollar (MYR/SGD) and Singapore Dollar/Thai Baht (SGD/THB). These are called cross currency pairs or cross rates.
Cross currency trading also requires traders to conduct technical and fundamental analysis. A trader employs the same strategies that are used for trading in major currencies to generate signals for cross currency pairs. Cross currency pairs that involve the currencies of developing nations in Asia, the Middle East and Africa are usually associated with higher risk than other forex transactions.
Benefits of Cross Currency Pairs
Cross currency pairs simplify forex trading. A trader can directly convert one currency into another,
without first converting money into US dollars. This saves time and avoids unnecessary hassles.
Advantages of cross currency trading are:
1. Price fluctuations in cross currency pairs are usually lower than in pairs involving the US dollar.
Cross currency pairs are, thus, suitable for traders who are new to the forex market.
2. Cross currency pairs can be used to diversify the portfolio.
3. Cross currency trading offers high profit potential.
Drawbacks of Cross Currency Pairs
The drawbacks of cross currency trading are:
1. Cross currency markets are highly insecure.
2. The political and financial scenario of underdeveloped and developing countries
can change suddenly, resulting in high risk.
Find out more about
Cross Currency Swaps.