Cross currencies are currency ‘pairs’ that omit the US dollar - the bulk of global exchange rate transactions involve the US currency or ‘greenback’. Cross currencies are where other currencies are allowed to be the dealmaker.
Buying and selling cross currencies provides an opportunity for bigger currency swings. That’s because currency pairs not twinned to the US dollar can fluctuate by greater extremes.
Traders can trade weaker economies against stronger ones. So there is potential for greater profits, as well as greater losses. Cross currency trading is also highly useful for hedging purposes.
- Cross currencies are about major currencies not measured against the US dollar, for example the pound/yen, GBP/JPY or the euro/Swiss franc, EUR/CHF
- The first currency, left, is ‘the base’ currency, the second currency, on the right, is ‘the quote’
- Interest rates are a key part of currency moves
The spread costs are wider on cross currencies. That’s because costs depend on how actively a currency pair is traded – basic supply and demand.
When you trade different currencies you have the sell price (or bid) and the buy (or ask) price. The difference between the two is the spread – the cost of placing that trade.
Currency moves are measured in pips. Most major currencies are quoted to the fourth or sometimes fifth (even sixth) decimal place. If you were to look at, say, a EUR/GBP spread you might see a sell/bid price of 0.8486 with a buy/ask price of 0.8487 (late April 2017).
That’s a spread of one pip. In this example, one euro is worth 85 pence.
The small spread tells you how ‘liquid’ – how easy it is to buy and sell – a particular currency pair is.
If you were looking at sterling versus yen you might see GBP/JPY with a sell/bid price of 142.73 and a buy/ask price of perhaps 142.76 (late April 2017).
That’s a wider three-pip spread (the spread against the Japanese yen is usually quoted only to two decimal points). On some less ‘liquid’ currencies the pip spread can be as much at 10.
Diversification and strategy
Like buying shares in the stock market where you’ve an abundance of choice, cross currencies offer wide diversification.
Longer term it’s a good idea to have exposure to several currency pairs so it allows you to understand how the currencies respond to each other from economic or political news.
When you buy currencies you are effectively buying one currency and selling another. If you live in the UK and you buy dollars you are buying the US dollar at the same time you are selling sterling.
Effectively, that’s two transactions rather than one – though the price transaction is treated as one. This compares with buying shares on the stock market where you might only buy one stock – there is no immediate pairing with other stocks.