Understanding Currency Crosses: A Beginner's Guide

Do you want to trade currencies other than the U.S. dollar? If so, you need to learn about currency crosses. These forex pairs do not involve the U.S. dollar as the base or the quote currency.

This article will arm you with knowledge about currency crosses, their formation and the factors that influence their movements. You will also find practical strategies for trading currency crosses to achieve profitability.

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What are Currency Crosses?

Currency crosses are forex pairs that do not involve the U.S. dollar as either the base or the quote currency. For example, EUR/GBP, AUD/JPY and NZD/CAD are currency crosses.

A forex currency pair comprises a base and a quote currency. The base currency is the currency that is bought or sold, while the quote currency is the one that expresses the value of the base currency. For example, in the GBP/CAD pair, the British pound is the base currency, and the Canadian dollar is the quote currency. The common convention is to quote one British pound as being worth a certain amount of Canadian dollars.

Currency crosses allow traders to trade currencies that are not directly related to the U.S. dollar, which is the most traded and dominant currency in the forex market. Different currency pairs can provide more flexibility and variety in trading.

Forex Cross Currency Pairs

There are three categories of currency crosses — majors, minors and exotics. Each category has its unique features, benefits and drawbacks.

Majors Currency Crosses

Major currency pairs are the market's most traded and liquid forex cross-currency pairs. They usually involve one of these currencies: euro (EUR), British pound (GBP), Japanese yen (JPY), Canadian dollar (CAD), Swiss franc (CHF), Australian dollar (AUD) and New Zealand dollar (NZD).

Major currency crosses combine any two of these currencies, excluding the U.S. dollar. For example, EUR/JPY, GBP/CHF and AUD/NZD are major currency crosses and tend to have lower spreads and higher liquidity than other currency crosses. They often track the trends and movements of their main currency pairs, which include the U.S. dollar. For example, EUR/JPY tends to move in sync with EUR/USD and USD/JPY.

However, major currency crosses can also have their dynamics and drivers independent of the U.S. dollar. For instance, Brexit, monetary policy divergence and trade relations between the EU and the U.K. are some factors that influence EUR/GBP.

Minor Currency Crosses

Minor currency pairs, typically less traded and liquid than their major counterparts, consist of one major currency coupled with one minor currency. These minor currencies do not qualify as either major or exotic currencies.

Currency crosses formed by pairing two minor currencies, excluding the U.S. dollar, are known as minor currency crosses. Examples include SGD/HKD, NOK/SEK and ZAR/MXN. These crosses tend to have higher spreads and lower liquidity compared to major currency crosses, making them more volatile and unpredictable. This increased volatility is because of their susceptibility to domestic economic health, political happenings and overall market sentiment.

Still, trading with minor currency crosses has some advantages. They offer traders unique opportunities to diversify their portfolios. Minor currency crosses can provide exposure to emerging, regional or niche markets with different growth opportunities and risk profiles than the mainstream major markets, thus extending the potential for more diversified and opportunistic trading in the forex market.

Exotic Currency Crosses

Exotic currency pairs consist of one major and one exotic currency and are the least traded and liquid pairs in the forex market. An exotic currency typically belongs to a developing nation or a small economy and is not widely traded or accepted internationally.

Exotic currency crosses are formed by coupling any two exotic currencies except the U.S. dollar. These include TRY/RUB, BRL/INR and IDR/THB. Characterized by exceptionally high spreads and remarkably low liquidity, these exotic currency crosses are considerably more volatile and risky than other currency crosses. This volatility and risk stem from their sensitivity to political and economic instability, fluctuating inflation and interest rates, capital controls and interventions by central banks or governments.

For traders willing to take on greater risks and challenges, exotic currency crosses can present potential rewards. These pairs offer an entry point to high-growth or high-yield markets or those with unique characteristics or opportunities not found elsewhere in the forex market. Exotic currency crosses are gateways to exciting, albeit risky, trading horizons.

Factors Affecting Currency Crosses

Trading currency crosses requires a good understanding of the fundamental and technical factors that affect their movements. Fundamental analysis involves looking at the economic, political and social factors that influence the supply and demand of currencies. Technical analysis studies the price patterns, trends and indicators that reflect traders' market sentiment and psychology.

Some of the common factors that affect currency crosses are:

• Economic indicators: Economic indicators are statistics that measure the performance and health of an economy, such as GDP, inflation, unemployment, trade balance and consumer confidence. They can have a positive or adverse impact on the value of a currency, depending on whether they meet, exceed or miss market expectations.
• Geopolitical factors: Geopolitical factors are events or situations that involve relations or conflicts between countries or regions, such as wars, elections, referendums, trade wars and sanctions. They can create uncertainty or risk in the market, affecting the demand for safe-haven currencies (such as JPY and CHF) or riskier currencies (such as AUD and NZD).
• Market sentiment: Sentiment is the overall mood or attitude of traders towards a particular currency or market based on their expectations, emotions and preferences. It can be bullish (optimistic), bearish (pessimistic) or neutral. It can also change quickly depending on the news, events or rumors that affect the market.

It helps to stay updated on the global events and developments that can affect currency crosses, using various sources of information and analysis, such as news websites, economic calendars, trading platforms, blogs and podcasts.

Strategies for Trading Currency Crosses

There are different strategies for trading currency crosses, depending on the trader's style, goals and risk tolerance. Some of the common ones include:

Trend Following

This strategy involves identifying and following the direction of the dominant trend in a currency cross, using tools such as trend lines, moving averages or indicators such as MACD or ADX. The trader enters a long position when the trend is upward and a short position when it is downward. The trader exits the position when the trend reverses or shows signs of weakness.

Range Trading

With range trading, traders identify and trade within a range or a channel in a currency cross. A range is a period of consolidation or sideways movement in a currency cross, where the price fluctuates between a support level (the lower boundary) and a resistance level (the upper limit). The trader buys at the support level and sells at the resistance level. The trader exits the position when the price breaks out of the range or shows signs of exhaustion.

Breakout Trading

This strategy centers on detecting and acting on breakouts in a currency cross's range. A breakout — a sudden, notable shift in a currency cross — hints at changes in supply and demand. Breakout triggers include news, economic data or technical signals. Traders go long when prices exceed a resistance level and short when they fall below a support level. Traders exit positions when a price target is reached or a reversal is indicated.

Regardless of the strategy, you must practice proper risk management and discipline when trading currency crosses. Set up stop-loss orders to limit losses in case of unfavorable market movements. Try to adjust position sizes according to risk-reward ratios and follow trading plans and rules consistently.

Trade Currency Crosses Like a Pro

Currency crosses are forex pairs that do not include the U.S. dollar as either the base or the quote currency. They offer more opportunities and diversification for traders who want to trade currencies other than the U.S. dollar. However, trading currency crosses also requires more knowledge and skills than trading major pairs that involve the U.S. dollar. Traders need to understand currency crosses and learn to apply different strategies for trading them effectively and profitably.

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