Im Reading through the Forex School lessons and came across this part of the article:
„ A cross-currency is any [currency pair]in which neither currency is the U.S. dollar.
These pairs exhibit erratic price behavior since the trader has, in effect, initiated two USD trades.
For example, initiating a long (buy) EUR/GBP is equivalent to buying a EUR/USD currency pair and selling GBP/USD.“
I do not understand why that would be the case. Could anyone explain this to me?
Technically every transaction involves the US Dollar. If you wanted to trade EUR/GBP you would have to manually buy EUR/USD and manually sell GBP/USD. This would get you long on EUR, short on GBP and the two USD’s would cancel out (long on one and short on the other). Now you can do that by buying the EUR/GBP and not worrying how it gets done behind the scenes. Basically the idea of cross currencies being available makes trading them a lot easier.
Or…
When we as private retail forex traders trade, do not think we are buying and selling currency. We are betting that the exchange rate between two currencies will rise or fall. So if you buy EUR/GBP, you and the broker agree that they will pay you money if the exchange rate rises, and you will pay them if it falls.
Of course, you could gain the same benefits if you opened two trades - buy EUR/USD and sell GBP/USD. Again, you will benefit if EUR rises and GBP falls, but it makes no difference to your trade what USD does - because you have both bought and sold USD, changes in the exchange rate between USD and the other currencies cancel each other out. Its like buying a car and selling a car at the same time - you end up with no car.
Hi Kapitalo,
When we say that initiating a long (buy) position in EUR/GBP is equivalent to buying a EUR/USD currency pair and selling GBP/USD, what we’re doing is expressing the cross-currency trade in terms of trades that involve the US dollar (USD). This has to do with how forex trades are typically quoted and executed in the market, with the US dollar serving as the main international reserve currency.
Here’s a breakdown:
When you buy EUR/GBP, you’re buying the Euro (EUR) and selling the British Pound (GBP). That’s the direct meaning of that trade.
But, let’s express this trade in terms of USD trades:
Buying EUR/USD: This means you’re buying Euros (EUR) and selling US dollars (USD). This part of the operation aligns with your original intent of buying Euros.
Selling GBP/USD: This means you’re selling British Pounds (GBP) and buying US dollars (USD). This part of the operation aligns with your original intent of selling British Pounds.
So you can see that these two operations with the USD pairs lead to the same overall effect as the direct trade of buying EUR/GBP. This is why it’s often said that trading a cross-currency pair is like trading two USD trades.
One final note: because these transactions involve more than one direct trade, cross-currency pairs can sometimes be less liquid and exhibit more volatility than the main currency pairs that involve the US dollar. This is part of what the article meant when it referred to the “erratic price behaviour” of cross-currency pairs.
Cross-currency pairs show erratic price behavior because when you trade them, it’s like doing two separate trades involving the U.S. dollar. For instance, buying EUR/GBP means you’re buying EUR/USD and selling GBP/USD at the same time. This interaction between two USD trades can make things unpredictable.