Hello, I wanted to present/ask this cross currency trading risk in Q/A forum section but there doesn’t seem to be “Post New Thread” button…
OK Let’s assume I have an account that is based on euros, ie. I have 10 000€ balance in my forex trader platform. And I want to buy US dollars vs. japanese yen. that is USD/JPY pair.
According to forex definition which says for currency pair that “currencies are exchanged for each other simultaneously”, in order to buy dollars (USD/JPY) I need yen right?
But my account is in Euros so upon taking long position to buy USD/JPY my account balance which is in euros will be charged to buy yen first, then those yens will be used to buy dollars? Is that correct?
let’s suppose it’s not and my Euro account balance is charged directly to buy dollars without purchasing yen first, that is to buy dollars with my euros against the yen.
please explain which one of these two statements is true and why the other statement is false if so?
Also the same case as above, let say I want to buy yen against the dollar instead (vice-versa), then I suppose procedure will be to (automatically)buy dollars first and then these dollars will be used to buy yen for dollars in order for position to be open, right?
If you have read carefully you noticed that upon taking a position there are TWO currency conversions to take position, and TWO currency conversions to close it, that is there are made 4 currency conversions in total for one single position.
Now let’s assume you managed to profit from this trade 10€ and your balance is now 10 010€.
well this is absolutely not true, because there is a risk that in mean time while your trade is open, dollar lose it’s value vs euro, so when dollars are exchanged back to euros during position closing you may lose some profit.
If you have comments or explanation then please reply.
Changes in the EUR/JPY will effect a USD/JPY trade for a trading account denominated in euros by changing the pip cost for the USD/JPY pair.
Take a look at your quotes and look at the pip cost value for USD/JPY. If you watch the pip cost values over time they will change with exchange rates.
When a euro denominated trader goes long USD/JPY, he borrows yen to buy dollars to open the trade and sells dollars for yen to repay the yen borrowed to close the trade. If he profits from the trade, he exchanges his profit dollars for euros at a rate according to the pip cost quoted in euros by his broker which is calculated based on the EUR/JPY rate.
If the dollar loses value against the euro during the USD/JPY trade for the euro denominated trader, this change will simply lower the pip cost for the trade; it will lower both profitability and risk per pip. Conversely, if the dollar gains value against the euro during the trade, this change will magnify the profitability and risk per pip.
As you are probably aware, the dollar has gained against most currencies since this last summer. As a result, dollar denominated traders (like me) currently see lower pip costs on their trades than what they saw last summer.
These quotes offered by FXCM are available for comparison. The 2014 quotes on the left show different pip costs than the quotes on the right from November of 2012.
EUR/JPY had a pip cost of .12 in 2012. Today, the pip cost is just .08.
CHF/JPY had a pip cost of .12 in 2012. Today, the pip cost is just .08.
GBP/AUD had a pip cost of .10 in 2012. Today, the pip cost is just .08.
I think the changes in the pip costs are what you are looking for in answer to your question.
May your cup overflow and your account grow.
P.S. There are no pairs listed as XXX/EUR. In all euro pairs, the euro is the base pair. This was a stipulation adopted with the formation of the ECB and the euro. As a result, a euro denominated trading account will not have any pairs with constant pip costs, they will all change. U.S. traders with dollar denominated accounts are accustomed to trading certain pairs wherein the dollar is not the base currency such as EUR/USD, GBP/USD, AUD/USD, NZD/USD. With these (and you will notice if you check the above image) the pip cost is ALWAYS .10.
Thank you zillion times for your help!
I have some additional questions because I do not understand 2 points from your reply:
What do you mean by “he borrows”? are you saying that yen does not have to be purchased with euros and instead the yen is borrowed just like that with no charge on euro balance? but how do you calculate margin then if no purchase from the balance is made?
how can EUR/USD rate have an impact on an open trade of USD/JPY? did you mean upon closing a trade?
and also how will that “lower risk” per pip?
I never used fxcm, but as you described it looks that their spreads are too high
Thank you!
The trader has the obligation to buy back the same number of yen as he sold for dollars and then return those yen to close the position. That obligation can be considered a debt or loan. If you simply bought yen with euros and instantly bought dollars with yen to hold until rates changed, you would simply be short the EUR/USD pair because you could just close that position by buying euros with dollars; there would be no reason to touch the yen at all.
In order for a euro denominated account holder to benefit from changes in the exchange rate in the USD/JPY pair, he must hold debt denominated in yen AND cash denominated in dollars or vice versa. If a euro denominated account holder simply bought yen, he would be shorting the EUR/JPY pair. If he simply bought dollars he would be shorting the EUR/USD pair. It does not matter if you use no margin at all, you must borrow the yen and sell them for dollars to benefit from a USD/JPY long position.
The pip cost is the amount of money denominated in your home currency you will win or lose per pip in a trade. If you lose ten pips in a trade with a pip cost of .08, you lose .80. The pip cost is a function of the exchange rate between the currency in which your account is denominated and the counter currency in the pair you are trading. If you have a euro account and the yen gains against the euro, the pip cost for the USD/JPY pair will go down. That is the answer to your initial question wherein you were saying: “there is a risk that in mean time while your trade is open, dollar lose it’s value vs euro, so when dollars are exchanged back to euros during position closing you may lose some profit.” It is just not the dollar vs the euro but the yen vs. the euro that matters.
It occurred to you that changes in the exchange rate between the euro and the dollar should effect a USD/JPY trade for a trader with an account denominated in euros but you were not sure exactly how. The answer is that the pip cost for the USD/JPY pair will change for that trader with the changes in the EUR/JPY exchange rate. So you were close.
Exactly this^
Just to confirm… so in my example, pip cost for long USD/JPY pair will fluctuate constantly while position is open according to both short EUR/USD rate and long USD/JPY rate?
Thank you so much for all your time, I actually asked this questions on many forums and only here was able get an answer, it’s funny how out of all online forex traders nobody know how this works.
so again THANK YOU!
Oh shix. I just noticed that I misspoke. Sorry to confuse you. The pip cost fluctuates with the exchange rate between your home currency and the [B]counter[/B] currency in the pair you are trading (not the base). So I should have said: “[I]The answer is that the pip cost for the USD/JPY pair will change for that trader with the changes in the EUR/JPY exchange rate.[/I]” (Not EUR/USD) So all throughout those posts I should have said EUR/JPY, not EUR/USD (I am american and used to thinking in terms of the dollar not the euro). I just edited all the posts so you can go back through and it should make more sense.
I am surprised nobody to whom you spoke seemed to understand that. But then, maybe I am not.
Here it is in a nutshell:
For 1 microlot traded, the pip cost is 10 times or .10 times (depending on whether the currency is expressed as a base or a counter against your own) the number of home currency units required to purchase 1 unit of the counter currency in the pair traded.
A forex quotation is listed “XXX/YYY” wherein the XXX currency is the “base” and the YYY currency is the “counter” in the pair. Just remember that the currency on the left of the pair is the base.
It currently takes .00682 euros to buy 1 yen. (1/146.6 = .00682). That number times 10 is .0682. So the pip cost on a microlot for a euro account trader on any pair wherein JPY is the counter currency (including USD/JPY, GBP/JPY, AUD/JPY, NZD/JPY) should be .0682, rounded up it is .07.
So just remember: 10 or .10 times the number of home currency units required to purchase 1 unit of the counter currency in the pair traded is the pip cost for a microlot.
Thank you so much for your time explaining how this works, I see now!!
It would be thankless from my side not to provide something in exchange for all your valuable explanations, actually I’m working on Excel spreadsheet calculator for forex, with all the possible formulas etc etc… also after reading several online tutorials on how some calculation is done it looks that some of calculus is dependent on broker too (such as margin calculation), so I took that into account.
Without your help my work would probably take ages so Thanks!
I will post a link to my spreadsheet when it’s done.
I’m still working on my Excel calculator, here is first version and can be used to calculate Forex risk. blah …
you can download it from my blog, the book has info included on how to use it. download here
A type of settlement risk in which a party involved in a foreign exchange transaction remits the currency it has sold, but does not receive the currency it has bought. In cross-currency settlement risk, the full amount of the currency purchased is at risk. This risk exists from the time that an irrevocable payment instruction has been made by the financial institution for the sale currency, to the time that the purchase currency has been received in the account of the institution or its agent.
@codekiddy. very good question/observation @arbitrager on acid. interesting answers. I never thought about it that way. Personally, I think that those exchange rates only come into play when you close a position. More or less what happens in shorting stocks… you borrow money to short a stock, but the real transaction happens when you close the position-resulting into a profit or loss. The difference is what affects you account.
