Trading in cross currency pairs offers significant opportunities to the forex trader.
Perhaps one of the most important benefits of trading crosses is that it gives the forex trader the possibility of considerably expanding their horizons in the forex market to a much wider group of trading instruments.
Nevertheless, it is important to keep in mind that cross currency pairs often do not offer the same degree of liquidity or the tight dealing spreads available in the major currency pairs that are traded against the U.S. Dollar.
Cross Trading Strategy Considerations
The lower level of liquidity and higher spreads often seen in the crosses can make trading them seem more of a challenge for individual retail traders, especially for those who prefer to use short term trading strategies like scalping.
As a result, a more long term strategy like trend trading might be a more appropriate approach to trading in the cross rate currency pairs for retail traders.
This strategy can be quite profitable since significant trends can often occur in the cross rate currency pairs over an extended period of time.
Carry Trades in Crosses
One popular longer term trading strategy which involves crosses consists of the carry trade. The carry trade basically has the trader purchasing a currency which yields a higher rate of interest than the currency which is being sold.
By establishing and then holding such a position, the trader is able to pocket the differential between the two interest rates for as long as the position is held.
In addition, hopefully the currency position will also appreciate to add an extra trading profit to the more reliable interest income expected.
Carry trades have been especially popular recently in AUDJPY, where the Australian interest rates have been at 4.5 percent while interest rates in Japan have been kept at very low levels between 0 and 1 percent over the past two years.
Cross Rate Arbitrage
Several of the major crosses trade actively and have their own dedicated Interbank brokers, as well as market makers that specialize in providing quotations.
Many such savvy cross rate forex traders will also actively arbitrage the market for the cross rates they deal in with the component currency pairs that include the U.S. Dollar.
For example, consider the situation where USD/JPY is trading at 90.00 bid and EUR/USD is trading at 1.2500 bid through their respective Interbank brokers. Nevertheless, a large Euro sell order just went through in EUR/JPY, making the offer for the cross at 112.48 through the Interbank EUR/JPY broker.
In this case, the market maker could sell Euros at 1.2500 and buy Japanese Yen at 90.00 individually, thereby making an effective sale rate for the EUR/JPY cross 112.50. They would then endeavor to buy the cross at 112.48 via the broker as quickly as possible to pick up a quick two pips with minimal risk.