Understanding Cross-Currency Pairs in Forex Trading

If you're new to the world of forex trading, understanding cross-currency pairs is a must. In this article, we'll break down what they are and how they work in order to help you get started in the world of online currency trading.

So, what are cross-currency pairs, and why are they important? Simply put, a cross-currency pair consists of any two currencies traded on forex, excluding the US Dollar. For example, a EUR/GBP pair would be considered a cross-currency pair.

Namely, there are two types of cross-currency pairs known in the forex trading world: minor currency pairs and exotic currency pairs. Both of these types have different levels of risk and are traded accordingly. All noteworthy characteristics of trading both types will be explained in more detail below, and we will show you how to use them in order to potentially earn a profit.

Cross-Currency Pairs Explained

So, why are cross-currency pairs important? When you trade in the forex market, you're always trading two currencies at once. By understanding how these pairs move against each other, you'll be better equipped to make informed trading decisions and take advantage of price movements in the market. With that in mind, let's dive into more detail about how cross-currency pairs work.

Minor Currency Pairs

Minor currency pairs are the most common type of cross-currency pairs. These pairs usually include the Euro (EUR), British Pound (GBP), Japanese Yen (JPY), and Swiss Franc (CHF). These pairs are typically more liquid than exotic currency pairs, meaning there is always more than enough trading volume, ensuring that the trades are less volatile and risky. This makes them ideal for beginners who want to start small and gradually build up their positions.

Exotic Currency Pairs

On the other hand, exotic currency pairs are less common than minor currency pairs and usually involve two currencies from emerging markets. Most examples of exotic currency pairs include the Mexican Peso (MXN), the Indian Rupee (INR), and the Russian Ruble (RUB). These pairs are more volatile, so they can be riskier than minor currency pairs. However, they may offer some potential for profit.

» Learn more: Major, minor, & exotic currency pairs

Benefits of Cross-Currency Pairs

Whether you’re trading a minor or an exotic currency pair, cross-currency pairs have some advantages, including:

• Access to a wider range of markets.
• Higher potential for profit in volatile markets.
• An easier time when it comes to diversifying and hedging risk.
• Access to liquidity for seamless trading conditions.
• Potential to profit from economic factors from multiple countries simultaneously.
• Lower transaction costs due to competitive spreads.

What to Consider When Trading Cross Pairs

When trading any cross-currency pair, it is important to remember the fundamental concept of correlating currency prices. This is where one currency pair will move in the opposite direction of another.

A typical example would be the EUR/USD and USD/JPY pairs. When the EUR/USD moves higher, the USD/JPY will typically move lower, and vice versa. Knowing this can help you balance out your portfolio and better manage risk when trading multiple pairs at the same time.

» New to trading? Here are the essential forex terms you should know

The Risks of Leverage

Another thing you need to keep in mind when trading cross-currency pairs is leverage. Namely, leverage is the amount of borrowing power that you have when trading an instrument.

As you can already guess, having a higher leverage ratio can be beneficial, as it allows you to trade with a higher volume, but it increases your risk factor as you will need to pay back the money you lost.

Leverage is usually represented in a 1:X ratio, where X represents your buying power for every $1 in your account. For example, 1:10 leverage allows you to trade with $10 for every $1 in your account. However, using leverage can be quite risky, so we suggest doing some research and finding the most suitable leverage ratio that works for you and your trading style.

» Need more help? See our trading ebooks and video tutorials

The Risks of Liquidity

Speaking of risks—liquidity, or lack thereof, can be a real concern when trading cross-currency pairs. Since these pairs are not nearly as popular or liquid as the major ones, you may face difficulties when it comes to finding a buyer or seller.

This is why it's important to always check the liquidity of any pair you are thinking about trading, and make sure you have adequate capital to cover any potential losses.

Finally, it is important to understand the fundamentals behind each currency pair and have a good understanding of the macroeconomic factors that can affect the markets. This will help you make more informed trading decisions and give you a better idea of when to enter or exit a position.

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In a Nutshell

Cross-currency pairs allow traders to diversify their portfolios and utilize different economic conditions in various countries. However, it is important to be aware of the risks involved when trading cross-pairs and be aware of liquidity issues that may arise.