Why You Should Trade the Crosses?
It is of utmost importance for you as an individual trader to find the right currency pair to trade. As an individual/retail trader, you will only have $5,000 to $10,000 as equity in your trading account. Opportunity cost is a real cost for you as an individual trader. If you commit your funds to anyone position, those funds cannot be used in other possibly more profitable trades.
In forex trading, almost every currency pair is linked to another, one way or the other. As an individual/retail trader, if you only trade USD, you risk missing promising trades and opportunities offered by other currency pairs especially the crosses.
Although most of the dealing is done through the direct buying/selling of US dollar, you should always keep an eye on the crosses in order to gauge the strength/weaknesses of a currency. This will in the end tell you which pair is the best to trade.
You may ask, what are the crosses? Currency pairs that do not involve USD are known as Crosses such as EUR/JPY, EUR/GBP, EUR/AUD, CHF/GBP etc. Almost more than 90% of the currency pairs that are actively traded in the forex markets involve the USD. In simple language, over 90% of the all the currency trades have USD on one side of the trade either long or short. So what is so special about a cross that you should know?
Lets make it clear with an example. A good method to trade equities is to trade from big to small. Suppose, you determine that the stock market is bouncing and is expected to rise. But you have limited funds as an individual investor; so you should choose your stocks carefully.
It would be advisable to look at the sector specific indices and find the most promising sector. From there, you would look within the index and find the most promising companies that are expected to perform well over the coming months. This big to small thinking is very solid and you need to think in the same fashion while trading forex.
Cross movements should never be overlooked. Cross movements can often hide the footsteps of large players. A major investor may be bullish on Euro due to some fundamental reasons. He may try to fly under the radar and buy Euros against Swiss Francs, Pound Sterling, and Yen etc.
Crosses are extremely important to swing or momentum traders, they are used as forecasting tools to predict which currencies are leading the pack. Ignore the crosses and you will be stuck often with currency pairs that do not move at all.
With limited funds, you should always try to choose the currency pair that is expected to move the most. But, how exactly you come to a reasonable conclusion? By looking at the crosses!
Cross movements either work to amplify the move or minimize the effects. For example, if Euro is dropping against US Dollar but rising against the Pound, the net effect would be to limit the size of the EUR/USD fall. When ERU/GBP is rising, it is telling us that the Euro is outperforming the Pound.
Limited funds means you need to choose the best currency pair? Any EUR/USD selling pressure is likely to be offset by the buying pressure of EUR/GBP. GBP/USD sales are likely to be amplified by the cross sales EUR/GBP.
Since, EUR/GBP is rising; it would be better to short GBP also called the Cable instead of Euro. In simple words, you should short the pair GBP/USD; the chances are you will make many pips as compared to shorting EUR/USD. If we had not done our homework and randomly picked one of the two currency pairs for shorting, we may have missed a good opportunity.
