A cross currency refers to a currency pair or transaction that does not involve the U.S. dollar. … A cross currency pair is one that consists of a pair of currencies traded in forex that does not include the U.S. dollar. Common cross currency pairs involve the euro and the Japanese yen.
Over 80% of the transactions in the forex market involve the U.S. dollar. This is because the U.S. dollar is the reserve currency in the world.Most agricultural and commodities such as oil are priced in U.S. dollars.
If a country needs to purchase oil or other agricultural goods, it would first have to change its currency into U.S. dollars before being able to buy the goods.
This is why many countries keep a reserve of U.S. dollars on hand. They can make purchases much faster with Greenbacks already in their pocket.
Countries such as China, Japan, and Australia are examples of heavy importers of oil, and as a result, they keep huge reserves of U.S. dollars in their central banks.
In fact, China has over 3 trillion U.S. dollars in its reserve stockpile!
Currency Crosses Provide More Trading Opportunities
Instead of just looking at the seven “major” dollar-based pairs, currency crosses provide more currency pairs for you to find profitable opportunities!
By trading currency crosses, you give yourself more options for trading opportunities because these currencies are not bound to the U.S. dollar, thus possibly having different price movement behaviors.
So while the majority of the markets will only trade on anti-U.S. dollar or pro-U.S. dollar sentiments, you can find new opportunities in currency crosses.
For example, all the dollar-based pairs might be trading sideways or in some uglier fashion where it would be smart to just SIT on the sidelines and WAIT for better trade setups.
Since a majority of the forex market will deal with the U.S. dollar, you can imagine that many of the news reports will cause U.S. dollar-based currency pairs to spike.
The US has the largest economy in the world, and as a result, speculators react strongly to U.S. news reports, even if it doesn’t cause a huge fundamental shift in the long run.
What this means for your charts is that you will see several “spikes” even if there is a trend emerging. This can make it harder to spot trends or range indications.
Trade Interest Rate Differentials
By selling currencies whose country has a lower interest rate against currencies whose country has a higher interest rate, you can profit from the interest rate differential (known as a carry trade) as well as price appreciation.Currency crosses offer many pairs with high interest rate differentials that are prime for these types of trades.Currency crosses offer many pairs with high interest rate differentials that are prime for these types of trades.For example, take a look at the nice uptrend on AUD/JPY. If you had a long position on this pair, you would’ve made a hefty profit.
On top of that, the interest rate differential between AUD and JPY was huge.
From 2002 to 2007, the Reserve Bank of Australia had raised rates to 6.25% while the BOJ kept their rates at 0%.
That means you made profits off your long position AND the interest rate differential on that trade!
Trade Fundamentals With Currency Crosses
In the chart above, notice the relative strength of AUD/JPY vs. AUD/USD.
You’re not limited to just these currency pairs, you could’ve compared AUD against like EUR, GBP, and CAD.
From there, you can look for the weakest currency to trade against.
It’s your job as a forex trader to take advantage of certain opportunities so that you can put some silver dollars into your piggy bank.
Because of currency crosses, you now have the opportunity to match the currency of the best-performing economy against that of the weakest economy without having to deal with the U.S. dollar.
The most popular EUR crosses are EUR/JPY, EUR/GBP, and EUR/CHF.
News that affects the euro or Swiss franc will be felt more in EUR crosses than EUR/USD or USD/CHF.
U.K. news will greatly affect EUR/GBP.
Oddly enough, U.S. news plays a part in the movement of the EUR crosses. U.S. news makes strong moves in GBP/USD and USD/CHF.
This not only affects the price of the GBP and CHF against the USD, but it could also affect the GBP and CHF against the EUR.
A big move higher in the USD will tend to see a higher EUR/CHF and EUR/GBP and the same goes for the opposite direction.
Trading the Yen Crosses
The JPY is one of the more popular cross currencies and it is basically traded against all of the other major currencies.
EUR/JPY has the highest volume of the JPY crosses according to the latest Triennial Central Bank Survey from the Bank for International Settlements.
GBP/JPY, AUD/JPY, and NZD/JPY are attractive carry trade currencies because they offer the highest interest rate differentials against the JPY.
When trading JPY currency cross pairs, you should always keep an eye out on the USD/JPY.
When key levels are broken or resisted on this pair, it tends to spill over into the JPY cross pairs.
For example, if USD/JPY breaks out above a key resistance area, it means that traders are selling off their JPY.
This could prompt the selling of the JPY against other currencies. Therefore you could expect to see EUR/JPY, GBP/JPY, and other JPY crosses to rise as well.
Over recent years, this currency cross has become very popular, becoming highly correlated with the price of oil.
Canada is the second-largest owner of oil reserves and has benefited from the rise in oil prices.
On the other hand, Japan is heavily reliant on the importing of oil. In fact, over 99% of Japan’s crude oil is imported as it has almost no native oil reserves.
These two factors have caused an 87% positive correlation between the price of oil and CAD/JPY.