A cross-currency pair (or cross, for short) is any currency pair
that does not have the U.S. dollar as one of the currencies in the pairing. (Check my post Major Cross-Currency Pairs for a list of all different cross pairs). But the
catch is that cross rates are derived from the prices of the underlying USD
pairs. For example, one of the most active crosses is EUR/JPY, pitting the two
largest currencies outside the U.S. dollar directly against each other. But the
EUR/JPY rate at any given instant is a function (the product) of the current
EUR/USD and USD/JPY rates.
The most popular cross pairs
involve the most actively traded major currencies, like EUR,/JPY, EUR/GBP, and
EUR/CHF. According to the 2004 BIS survey of foreign exchange market activity,
direct cross trading accounted for a relatively small percentage of global
daily volume - less than 10 percent for the major crosses combined.
But that figure significantly
understates the amount-of interest that is actually flowing through the
crosses, because large interbank cross trades are typically executed through
the USD pairs instead of directly in the cross markets. If a Japanese
corporation needs to-buy half a billion EUR/JPY (half a yard, in market parlance), for example, the interbank
traders executing the order will; alternately buy EUR/USD and buy USD/JPY to
fill the order. Going directly through the EUR/JPY market would likely be
impractical, and would tend to tip off too many in the market and drive the
rate away from them.
For individual traders dealing
online, however, the direct cross pairs offer more than ample liquidity and
narrower spreads than can be realized by trading through the dollar pairs.
Additionally, most online platforms do not net out positions based on overall
dollar exposure, so you’d end up using roughly twice the amount of margin to
enter a position through the dollar pairs to create the same net market
position you'd have if you’d gone through the direct cross market. The advances
in electronic trading technology even make relatively obscure crosses like
NZD/JPY and GBP/CHF easily accessible to individual online traders.
