Understanding Currency Cross Rates
Understanding Cross Currency Rates
Before one currency gets converted into another, in most cases, it first gets converted into US Dollars. However, all those currency conversions that happen in foreign exchange, wherein one currency directly gets converted into the other currency (without converting it first to USD), are called currency cross rates.
The forex market is known to let the currency traders to trade with any pair of currencies around the world. However, some of the most commonly used currencies for trading (also called as “majors”) include U.S. Dollar, Euro, British pound, Japanese Yen, and the Canadian Dollar. One of the most popularly used pairs for trading is the Euro/USD. The US Dollar, being the most traded currency in the world, gets included in most pairs for forex trading. Some of the other popular currency pairs (such as GBP/JPY) that do not include the US Dollar, nor do they involve the conversion into US Dollar (before actual conversion from one currency to the other) are called as “cross currencies”.
Any one and everyone can trade with cross currencies. But, how can an American investor trade with cross currencies when his basic currency is the US Dollar? Well, the American investor will just need to make two transactions to be able to do so. Assume an American investor who wants to buy British pound against the Japanese Yen (GBP/JPY). To start with, the investor will need to purchase the Japanese yen against the US Dollar that he or she has. This will be the first step of the transaction. Thereafter, the investor can buy British Pound against the Japanese yen that he just purchased. This would complete the second step transaction. So, the American investor’s intention of buying British pound against the Japanese Yen (GBP/JPY) gets fulfilled.
The biggest advantage of cross currency trading is that the trader does not have to worry about the fluctuation of the US Dollars. This is because the US Dollars are not involved at all in the cross currency trading. For example, the forex currency pairs like GBP/USD, Euro/USD, and USD/CHF are heavily dependent on the exchange rate of U.S Dollar. Such currency pairs can only make profit if the U.S Dollar is weak. The same is not so with cross currency rates.
A trader can explore new opportunities with cross currency trading. This trading is not regularly used by many, and hence, it remains very much unexplored. Innovative traders can therefore, explore the possibilities of making higher profits here. Cross currency trading is not for you, if you are a beginner. This is for those investors, who have an in-depth knowledge of the currency trading market.
There is also a lot of talk about cross currency triangulation these days. The important point here is that most of the “spot currency cross pairs” are not traded head-on to each other in the interbank trading as the standard pairs. With the adoption of Euro, many cross currency pairs like EUR/JPY, GBP/CHF, GBP/JPY, etc, began getting explored. Most companies and importers needed a way out to trade in the Euros, while earning the profits in their home currency and eventually, cross currency trading developed a lot in the past few years.
The U.S Dollars are nevertheless the most commonly used currency in the forex trading. If we dig down the history, after the Second World War, the U.S Dollar was the only currency that the world trusted the most. This was essentially because United States was the only country that suffered the minimum of losses in the war. This is what prompted the rest of the world to trade in U.S Dollars.
Find out here why Currency Cross Rates must be examined!