Trading the EUR crosses

Outside of EUR/JPY, EUR cross action tends to be concentrated in EUR/GBP and EUR/CHF, where the cross direction is largely determined by changing outlooks between the Eurozone economy relative to the UK and Swiss economies. Reactions to Eurozone and Swiss news or data are most likely to be felt in the EUR crosses as opposed to EUR/USD or USD/CHF, whereas UK news/data is going to explode all over GBP/USD and EUR/GBP.

Sharp USD-driven moves will also affect these crosses, with the brunt of the USD move being felt in GBP/USD and USD/CHF, frequently biasing those legs to drive their EUR cross in the short run. That means frequently (but not always) that a sharp move higher in the USD will tend to see a higher EUR/CHF and EUR/GBP, while a rapid USD move lower will tend to see lower EUR/CHF and EUR/GBP.

The pip values of these EUR crosses will be denominated in either GBP or CHF, with GBP significantly more expensive on a pip basis than CHF. Typical daily ranges in the EUR crosses are relatively small on a pip basis - roughly 20 to 40 pips on average, but they’re still substantial on a pip-value basis and roughly equivalent to daily EUR/USD ranges. 

Strecthing The Leg

A lot of interbank cross trading volume does not go through the direct cross market, because institutional traders have a vested interest in hiding their operations from the rest of the market. In many cases, too, standing liquidity is simply not available in less-liquid crosses (GBP/JPY or NZD/JPY, for example). So they have to go through the legs, as the dollar pairs are called with respect to cross trading, to get the trade done. They also have an interest in maximizing the prices at which they’re dealing - to sell as high as possible and to buy as low as possible.

One of the ways they’re able to do that is to alternate their trading in the dollar legs. For instance, if you have to sell a large amount of EUR/JPY, you can alternate selling EUR/USD, which may tend to drive down EUR/USD but also push USD/JPY higher (because U.S. dollars overall are being bought). You now (you hope) have a higher USD/JPY rate at which to sell the JPY leg of the order. But selling USD/JPY may push USD/JPY lower or cap its rise, leading EUR/USD to stop declining and recover higher, because U.S. dollars are now being bought. Now you have a slightly better EUR/USD rate to keep selling the EUR leg of the order. By alternating the timing of which U.S. dollar leg you’re selling, you have (you hope) executed the order at better rates than you could have directly in the cross and likely managed to obscure your market activity in the more active dollar pairs.

Of course, it doesn’t always work out as neatly and cleanly as what we just described. The net result in the market is a steady directional move in the cross rate, while the USD pairs remain relatively stagnant or within recent ranges. Be alert for such dollar-based movement, and consider that it may be a cross-driven move and a potential trading opportunity.

Cross-rate movements can also have a pronounced effect on how individual dollar pairs move in an otherwise dollar-based market reaction. Let’s say some very USD-positive news or data has just been released, and the market starts buying USD across the board. (We focus on buying USD/JPY and selling EUR,/USD in this example.) If USD/JPY happens to break a key technical resistance level, it may accelerate higher and prompt EUR/JPY to break a similarly significant resistance level, bringing in EUR/JPY buyers. The net effect in this case is that EUR/USD will not fall as much or as rapidly as USD/JPY will rally, because of the EUR/JPY cross buying. If you went short EUR/USD on the positive U.S. news, you may not get as much joy. But the legs also tend to move in phases, and continued EUR/USD selling may eventually break through support, sending EUR/JPY lower and capping USD/JPY in the process. 

As you can see, crosses can affect the market in virtually limitless ways, and there’s no set way these things play out.

When the U.S. dollar is not the primary focus of the market’s attention, or if major U.S. news is approaching (like a non-farm payrolls [NFP] report or a Federal Open Market Committee [FOMC] decision in a few days), sending market interest to the sidelines, speculative interest frequently shifts to the crosses. Always consider that the market‘s focus may be cross-driven rather than centered on the USD or any other single currency. Some days it's a dollar market, and other days it's a cross market. GBP may be weakening across the board on weak UK data, but if the USD is similarly out of favor, the pound’s weakness is likely to be most evident on the crosses.

When looking at cross-trade opportunities, you may be tempted to translate the cross idea into a USD-based trade. You may think that AUD/JPY is forming atop, for example. If you're right, you may be thinking that one of two moves is likely USD/JPY will move lower or AUD/USD will move lower - and you may be tempted into selling one of the legs (AUD/USD or USD/JPY) because you don’t want to get involved in a cross. But there's another possibility: One leg may go down precipitously while the other moves higher, sending the cross lower, as you expected. But if you went short the wrong leg, you missed the boat.

When you spot a trade opportunity in a cross, trade the cross. Don’t try to outguess the market and pick which component will make the cross move. Trust that if your trade analysis is correct, the cross will move the way you expect.

Trading the JPY crosses

The JPY crosses constitute one of the primary cross families and basically pit the JPY against the other major currencies. EUR/JPY is the highest volume of the JPY crosses, but the prominence of the carry trade, where the low yielding JPY is sold and higher-yielding currencies are bought, has seen significant increases in GBP/JPY, AUD/JPY, and NZD/JPY trading volume. Those currencies offer the highest interest-rate differentials against the JPY.

JPY crosses have their pip values denominated in JPY, meaning profit and loss will accrue in JPY. The margin requirement will vary greatly depending on which primary currency is involved, with GBP/JPY requiring the greatest margin and NZD/JPY requiring the least.

In terms of JPY- cross fundamentals, JPY-based news and events tend to have the greatest impact, but as we caution earlier, trying to pin down which leg is going to cause the JPY crosses to move is a risky game. When trading in the JPY crosses, you need to keep an eye on USD/JPY in particular, due to its relatively explosive tendencies and its key place as an outlet for overall JPY buying or selling. Be alert for similar technical levels between USD/JPY and the JPY crosses, as a break in either could spill over into the other.

Calculating cross rates

Cross rates are a function of the prices of the underlying USD pairs. Depending how the dollar pairs are quoted (that is, whether the USD is the primary or the secondary currency), the cross rate is going to be either the product of multiplying the rates of two dollar pairs or the quotient of dividing the rates of two dollar pairs. But each currency quote has two sides: the bid and the offer.

To calculate the cross rate, EUR/JPY for example, look at each bid/offer of each dollar pair and ask yourself what it means. If EUR/USD is quoted as 1.3110/13, from the market-maker’s perspective the price of 1.3110 is where EUR are bought and USD are sold. The price of 1.3113 is where EUR are sold and USD are bought. If USD/JPY is quoted at 117.50/54, the price of 117.50 is where USD are bought and JPY are sold, and the price of 117.54 is where USD are sold and JPY are bought. To calculate the bid in EUR/JPY, you need to come up with the price that matches where EUR are bought and JPY are sold, which corresponds to a 1.3110 bid in EUR/USD (where EUR are bought) and a 117.50 bid in USD/JPY (where JPY are sold), resulting in a EUR/JPY bid rate of 154.0425 (1.3110 X 117.50). To calculate the offer of EUR/JPY, you’d use the offer side of both USD rates, in this case 1.3113 and 117.54, giving you a EUR,/JPY offer rate of 154.1302. Putting the two together and rounding a bit, you’d have a EUR/JPY quote of 154.04/13. But that’s a very wide spread, and the conventional market quote would be only 3 to 4 pips wide. In this case, an online trading platform would likely show a EUR/JPY price of 154.06/10 or 07/10. As you can see, you can get a tighter spread by dealing directly in the cross pair than you could ever get by going through the dollar pairs (or components or legs, as they‘re typically called).

The reality for online traders is that you don’t really need to know how cross rates are calculated, because the online trading platforms are doing it for you and narrowing the spread to boot.

Different cross pairs have different spreads depending on the spreads of the underlying USD pairs, with less-liquid and more-volatile pairs resulting in wider cross spreads. For instance, GBP/JPY is going to have a wider spread than EUR/JPY because of the lower liquidity and higher volatility of GBP/USD relative to EUR/USD. But because the components of wider-spread crosses are more volatile, the cross rates themselves will also be more volatile, allowing the spread to be recouped, typically in relatively short order.

Why trade the crosses?

Cross pairs represent entirely new sets of routinely fluctuating currency pairs that offer another universe of trading opportunities beyond the primary, USD pairs. Developments in the currency market are not always a simple bet on what‘s happening to the U.S. dollar. Crosses are the other half of the story, and their significance appears to be increasing dramatically as a result of electronic trading. Years ago, if you wanted a price in a cross pair, a human would have to push the buttons on a calculator to come up with the cross quote. Today’s streaming price technology means that cross rates are as fluid as the dollar pairs, making them as accessible and tradable as USD/JPY or EUR/USD.

In particular, cross trading offers the following advantages:

• You can pinpoint trade opportunities based on news or fundamentals. If negative Japanese news or data is released, you may be looking to sell the JPY. But against what? If the USD is currently weakening, buying USD and selling JPY may not yield any results. Selling JPY against another currency with better immediate prospects (such as buying EUR/JPY or AUD/JPY) may yield a more appreciable return.
• You can take advantage of interest-rate differentials. Selling low-yielding currencies against higher-yielding currencies is known as a carry trade. Carry trades seek to profit from both interest-rate differentials and spot price appreciation, and can form the basis of significant trends.
• You can exploit technical trading opportunities. The majors may be range bound or showing no actionable technical signals, but a cross rate may be set to stage a directional price breakout. Survey charts of cross rates to spot additional technical trading setups.
• You can expand the horizon of trading opportunities. Instead of looking at only four to seven dollar pairs, cross rates offer another dozen currency pairs that you can look to for trading opportunities.
• You can go with the flow. Speculative flows are ever-present in the currency market, but they don’t always involve the dollar pairs. Today's speculative flow may be focused on the JPY crosses or selling CAD across the board on the back of surprisingly weak CAD data. The more attuned you are to cross-currency pairs, the more likely you are to identify and capitalize on the speculative move du jour. 

Cross-Currency Pairs

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.