When changing currencies in the past, one had to first convert their existing currencies into U.S. dollars before exchanging those dollars for the new currency they wished. The U.S. dollar was referred to as a “vehicle currency” because it served as the primary means of exchange for cross-border trade. For instance, in order to convert U.K. sterling into Japanese yen, a person would first need to convert sterling into U.S. dollars, which would then need to be converted into yen. Currency crosses have made it possible for people to avoid the process of converting their own currencies into US dollars and instead change them straight into the desired currency.
What is a Currency Cross?
A currency pair or transaction that excludes the dollar is referred to as a cross currency. For instance, a cross-currency transaction does not employ the dollar as the contract settlement currency. A cross currency pair is a set of two foreign exchange trading partners that excludes the U.S. dollar. The euro and the Japanese yen are common cross-currency pairs. Some examples of crosses include GBP/JPY, EUR/JPY, EUR/CHF, and EUR/GBP.
History of Cross Currency
Most currencies were tied to and quoted against the dollar at the end of World War II. This was due to the U.S. economy being the strongest overall after the war and its currency being pegged to gold. This established standards for converting two different currencies.
In the past, if someone wanted to exchange a certain amount of money into another currency, they had to first convert it into US dollars, and then into the target currency. Under this system, cross-currency transactions were possible, although occasionally a U.S. dollar computation was required to ensure a fair settlement. Although the U.S. dollar continues to serve as the global reserve currency, cross currency transactions and cross currency pairs have become more widespread due to the development of the forex market. For instance, the GBP/JPY cross was developed to assist those in England and Japan who wished to exchange money without first converting it into US dollars.
Advantages of Currency Cross Pairs
Cross-currency transactions are a regular element of modern finance since the demise of the gold standard and the rise in wholesale global trade. Cross-currency transactions have not only made foreign payments simpler, but also significantly cheaper. There is only one transaction, which means only one spread is crossed, because there is no requirement for a person to first convert the currency into U.S. dollars. Additionally, because non-USD pairs are now more often traded, spreads have shrunk, making it even more affordable to switch currencies.
Forex Trading with Cross Currency Pairs
Forex traders can benefit greatly from cross-currency pairs as tools. Using the EUR/GBP to place a wager on the ongoing Brexit crisis is one example of how some cross currency trades can be put up to position traders on specific global events. Setting up separate positions with the USD/GBP and USD/EUR would make the same transaction more complicated and capital costly, but this strategy is nevertheless employed to construct exotic cross currency combinations that are not frequently traded. Japanese yen exchange rates are typical cross rates. Many traders profit from the carry trade, in which they hold a high yielding currency, such as the Australian or New Zealand dollars, and short a low yielding currency, such as the Japanese yen.
What is a Currency Pair in Forex?
A currency pair is a pairing of currencies where the value of one is relative to the other. For instance, EUR/USD is the value of the euro relative to the U.S. dollar. Currency crosses (or cross currencies) are the more liquid currencies that do not include the U.S. dollar in their pairing. Note that these are not exotic currencies like the Iraqi Dinar (IQD). Crosses include EUR/GBP, EUR/CAD, GBP/JPY, CAD/JPY, GBP/AUD, etc.
A quotation for two distinct currencies is referred to as a currency pair. It represents the exchange rate at which one unit of one currency would be exchanged for another. For example, if a trader is given the quote EUR/USD 1.13, it signifies that the trader can exchange 1 Euro and receive 1.13 US Dollars in return.
When the value of one currency changes, the value of that other currency also changes. If the EUR/USD exchange rate rises from 1.13 to 1.15 over the course of the following day, it indicates either that the Euro has gained value relative to the US dollar or that the US dollar has lost value relative to the Euro as it will now cost more US dollars to buy a single Euro.
What are the Major Currency Pairs?
Although different traders will define “major currency pairs” differently, most will include the four most frequently traded pairs: EUR/USD, USD/JPY, GBP/USD, and USD/CHF. The following is a list of the most popular currency pairs. They are traded extensively and represent some of the biggest economies on the planet. Smaller spreads typically result from higher volumes.
- EUR/USD – Euro Dollar
- USD/JPY – Dollar Yen
- GBP/USD – Pound Dollar
- USD/CHF – Dollar Swiss Franc
What are the Major Currency Crosses?
Of course, the most traded and popular currencies are some of the most often utilised currency crosses; popular examples include the EUR/GBP, GBP/JPY, EUR/JPY, and EUR/CHF. The USD is involved in all but the first two of the top 10 most traded currency pairs in the world, demonstrating its continued domination of the financial markets.
How are Currency Crosses Calculated?
Although currency crosses are now typically created as their own exchange rate, we could pretty accurately determine it using the following method even if we did not have this rate.
We must first decide which currency’s exchange rate will serve as our base rate; set it to one before determining what a currency cross should be priced at. The Euro becomes the base rate for any currency crossings in which it is involved; if the GBP is involved but not the Euro, the GBP becomes the base rate.
Once the base rate for our currency has been determined, you must then determine the exchange rates of each currency against the USD, also known as the legs of our currency cross. For simplicity’s sake, we can ensure that our first currency (GBP) is the base rate in its exchange against the USD and that the USD is the base rate in its exchange against the second currency by making sure we are utilising the bid (buying price) or ask (selling price) for both exchange rates. If this is the case, we can calculate the price of the currency cross by simply multiplying the bid and ask prices for the two legs.
Final thoughts
An option to trading the major currency pairs is to trade cross currencies (or currency crosses). A cross currency pair is a set of currencies where neither the base currency nor the quote currency is the US dollar. For instance, EUR/GBP is referred to as a “cross pair” because it lacks the US dollar, whereas USD/JPY is referred to as a “major pair” since it contains the US currency.
When traders add trading cross currency pairs to their arsenal of trading instruments, they have more options. If none of the major pairs have setups, you can search for trading opportunities on the cross pairs. This may occur when the cross pairs are extremely busy during a trading session while the major pairs are quiet or idle. For instance, the EUR/USD may be rather quiet during the Asian Session whereas the AUD/JPY may be extremely lively.
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