Chapter 9

Minor Currency Pairs and Cross-Currency Trading

In This Chapter

Branching out beyond the majors

Getting to know the minor dollar pairs and the Scandies

Finding opportunities in cross-currency trading

Understanding how cross-currency trading affects the overall market

Trading in the major currency pairs accounts for the lion’s share of overall currency market volume, but speculative trading opportunities extend well beyond just the four major dollar pairs (currency pairs that include the USD). For starters, three other currency pairs — commonly known as the minor or small dollar pairs — round out the primary trading pairs that include the U.S. dollar. Still more trading options are available in the currencies of Scandinavian nations that haven’t adopted the EUR, referred to as the Scandies. Then there are the cross-currency pairs, or crosses for short, which pit two non-USD currencies against each other.

In this chapter, we take a closer look at the minor currency pairs, Scandies, and cross-currency pairs to see how they fit into the overall market and offer an additional array of speculative trading opportunities. Although the USD is frequently the focus of the currency market, you’re going to want to know where the opportunities are when the spotlight isn’t on the greenback.

Trading the Minor Pairs

The minor dollar pairs are USD/CAD (the U.S. dollar versus the Canadian dollar) and NZD/USD (the New Zealand dollar versus the U.S. dollar). In the past, the AUD/USD (Australian dollar) was a minor currency, but trading volumes in the AUD have surged in recent years, so we include it in Chapter 8. Technically speaking, the Swissie should take the place of the AUD, but it rests somewhere between the majors and minors, so we haven’t included it here. Worth noting: The minor currency pairs are also commonly referred to as commodity currencies; the Aussie is still a commodity currency because Australia is still a major commodity producer.

The commodity currencies reference stems from the key role that oil, metals, agricultural, and mining industries play in the national economies of Canada, Australia, and New Zealand. See the nearby sidebar “The (not just) commodity currencies” for important qualifications about the commodity relationship. AUD/USD and USD/CAD account for 7 percent and 4 percent of global daily trading volume, respectively, according to the 2013 Bank for International Settlements (BIS) survey of forex market volumes. NZD/USD accounts for less than 2 percent each of spot trading volume. But these three pairs offer more than ample liquidity to be actively traded and can offer significant trading opportunities, both for short-term traders and medium- to longer-term speculators.

Trading fundamentals of USD/CAD

The Canadian dollar (nicknamed the Loonie after the local bird pictured on the dollar coins) trades according to the same macroeconomic fundamentals as most other major currencies. That means you’ll need to closely follow Bank of Canada (BOC) monetary-policy developments, current economic data, inflation readings, and political goings-on, just as you would any of the other majors.

A key element to keep in mind when looking at USD/CAD is that the trajectory of the Canadian economy is closely linked to the overall direction of the U.S. economy. The United States and Canada are still each other’s largest commercial trading partners, and the vast majority of Canadians live within 100 miles of the U.S./Canadian border. Even the BOC regularly refers to the U.S. economic outlook in its own economic outlooks. So we don’t think it’s an overgeneralization to say that as goes the U.S. economy, so goes the Canadian economy. But it’s a long-term dynamic, making for plenty of short-term trading opportunities, especially when U.S. and Canadian outlooks diverge.

The sharp rise in commodity demand from China and other rapidly developing economies in recent years has heightened the sensitivity of CAD to overall commodity price developments, although as China slowed in 2013–2014 and commodity prices seemed to have peaked, the relationship between CAD and commodities has also declined. However, it’s still worth factoring in the global economic outlook when evaluating the Canadian outlook.

Geography also plays a role when it comes to U.S. and Canadian economic data, because both countries issue economic data reports around the same time each morning or only a few hours apart. At one extreme, the result can be a negative USD report paired with strong Canadian data, leading to a sharp drop in USD/CAD (selling USD and buying CAD). At the other end, strong U.S. data and weak Canadian numbers can see USD/CAD rally sharply. Mixed readings can see a stalemate, but it always depends on the bigger picture.

Trading USD/CAD by the numbers

The standard market convention is to quote USD/CAD in terms of the number of Canadian dollars per USD. A USD/CAD rate of 1.0200, for instance, means it takes CAD 1.02 to buy USD 1. The market convention means that USD/CAD trades in the same overall direction of the USD, with a higher USD/CAD rate reflecting a stronger USD/weaker CAD and a lower rate showing a weaker USD/stronger CAD.

USD/CAD has the USD as the primary currency and the CAD as the counter currency. This means

• USD/CAD is traded in amounts denominated in USD. For online currency trading platforms, standard lot sizes are USD 100,000, and mini lot sizes are USD 10,000.
• The pip value, or minimum price fluctuation, is denominated in CAD.
• Profit and loss registers in CAD. For a standard lot position size, each pip is worth CAD 10, and each pip in a mini lot position is worth CAD 1. Using a USD/CAD rate of 1.0200 (which will change over time, of course), that equates to a pip value of USD 9.80 for each standard lot and USD 0.98 for each mini lot.
• Margin calculations are typically based in USD, so to see how much margin is required to hold a position in USD/CAD, it’s a simple calculation using the leverage ratio. At 50:1 leverage, for instance, $2,000 of available margin is needed to trade 100,000 USD/CAD, and $200 is needed to trade 10,000 USD/CAD.

USD/CAD is unique among currency pairs in that it trades for spot settlement only one day beyond the trade date, as opposed to the normal two days for all other currency pairs. The difference is due to the fact that New York and Toronto, the two nations’ financial centers, are in the same time zone, allowing for faster trade confirmations and settlement transfers. For spot traders, the difference means that USD/CAD undergoes the extended weekend (three-day) rollover after the close of trading on Thursdays, instead of on Wednesdays like all other pairs, assuming no holidays are involved. However, if you trade spot FX in the short term or with your FX broker, you usually don’t even notice these details about settlement dates (although understanding what’s going on is handy).

Canadian events and data reports to watch

On top of following U.S. economic data to maintain an outlook for the larger economy to the south, you’ll need to pay close attention to individual Canadian economic data and official commentaries. CAD can react explosively when data or events come in out of line with expectations. In particular, keep an eye on the following Canadian economic events and reports:

• Bank of Canada speakers, rate decisions, and economic forecasts
• Employment report
• Gross domestic product (GDP) reported monthly
• International securities transactions
• International merchandise trade
• Wholesale and retail sales
• Consumer price index (CPI) and BOC CPI
• Manufacturing shipments
• Ivey Purchasing Managers Index

Trading fundamentals of NZD/USD

The New Zealand dollar is nicknamed the Kiwi, as are most things New Zealand, after the indigenous bird of the same name; the term Kiwi refers to both the NZD and the NZD/USD pair. (What is it with birds and currency nicknames, anyway?) Given the relatively small size of the New Zealand economy, Kiwi is among the most interest-rate sensitive of all currencies.

The New Zealand economy has undergone a major transformation over the past two decades, moving from a mostly agricultural export orientation to a domestically driven service and manufacturing base. The rapid growth has seen disposable incomes soar; with higher disposable incomes have come generally high levels of inflation. As a result, the Reserve Bank of New Zealand (RBNZ), the central bank, has frequently been among the more hawkish central banks.

We put Kiwi in the commodity currency grouping, but there is an important distinction to note. New Zealand is primarily an agricultural-commodity-producing economy (dairy products and meat in particular), as opposed to the metals and energy commodities of Canada and Australia. As such, Kiwi displays a weaker relationship than CAD and AUD to the prices of gold, silver, and oil, as seen in the two tables in the previous sidebar.

In addition to all the standard New Zealand economic data and official pronouncements you’ll need to monitor, Kiwi trading is closely tied to Australian data and prospects, due to a strong trade and regional relationship.

No set formula exists to describe the currencies’ relationship, but a general rule is that when it’s a USD-based move, Aussie and Kiwi will tend to trade in the same direction as each other relative to the USD. But when Kiwi or Aussie news comes in, the AUD/NZD (Aussie/Kiwi) cross will exert a larger influence. For example, disappointing Aussie data may see AUD/USD move lower, which will tend to drag down NZD/USD as well. But Aussie/Kiwi cross selling (selling AUD/USD on the weaker data and buying NZD/USD for the cross trade) will typically reduce the extent of NZD/USD declines relative to AUD/USD losses. A similar effect will play out when New Zealand data or news is the catalyst.

New Zealand events and data reports to watch

RBNZ commentary and rate decisions are pivotal to the value of Kiwi, given the significance of interest rates to the currency. Finance ministry comments are secondary to the rhetoric of the independent RBNZ but can still upset the Kiwi cart from time to time. Additionally, keep an eye on the following:

• Consumer prices, housing prices, and food prices
• Retail sales and electronic-card spending (debit and credit)
• Westpac and ANZ consumer confidence indices
• Quarterly GDP and monthly trade balance
• National Bank of New Zealand (NBNZ) business confidence survey

Trading Aussie and Kiwi by the numbers

You can find out more about AUD in Chapter 8, but it’s worth looking at the numbers for AUD and NZD together as AUD/USD and NZD/USD are both quoted in the same way. AUD/USD and NZD/USD rates reflect the number of USD per AUD or NZD. For example, a NZD/USD rate of 0.7000 means it costs USD 0.70 (or 70¢) to buy NZD 1. Aussie and Kiwi trade in the opposite direction of the overall value of the USD, so a weaker USD means a higher Aussie or Kiwi rate, and a lower Aussie or Kiwi rate represents a stronger USD.

AUD and NZD are the primary currencies in the pairs, and the USD is the counter currency, which means

• AUD/USD and NZD/USD are traded in position sizes denominated in AUD or NZD.
• The pip values are denominated in USD.
• Profit and loss accrues in USD. On a 100,000 NZD/USD position, each pip is worth USD 10; on a 10,000 Aussie position size, each pip is worth USD 1.
• Margin calculations are typically based in USD on margin trading platforms.

Using an NZD/USD rate of 0.7000 and a leverage ratio of 50:1, a 100,000 Kiwi position requires USD 1,400 in margin, while a 10,000 NZD/USD position would need only USD 140 in margin.

Tactical trading considerations in USD/CAD, AUD/USD, and NZD/USD

We group these three currency pairs together because they share many of the same trading traits and even travel as a pack sometimes — especially Aussie and Kiwi, given their regional proximity and close economic ties. Whether they’re being grouped as the commodity currencies or just smaller regional currencies versus the U.S. dollar, they can frequently serve as a leading indicator of overall USD market direction.

Liquidity and market interest are lower

One of the reasons these pairs tend to exhibit leading characteristics is due to the lower relative liquidity of the pairs, which amplifies the speculative effect on them. If sentiment is shifting in favor of the U.S. dollar, for example, the effect of speculative interest — the fast money — is going to be most evident in lower-volume currency pairs.

When a hedge fund or other large speculator turns around a directional bet on the U.S. dollar (for example, from short to long), it’s going to start buying U.S. dollars across the board (meaning against most all other currencies). A half-billion EUR/USD selling order (650 million USD equivalent at 1.3000 EUR/USD) is relatively easily absorbed in the high-volume, liquid EUR/USD market and may move it only a few points (say, 10 to 20 pips, depending on the circumstances). However, a proportionately smaller order to sell Aussie, sell Kiwi, or buy USD/CAD (large speculators will typically allocate smaller position sizes to less-liquid currency pairs), amounting to only 100 million or 200 million in notional terms, may generate a 20- to 40-pip movement in these currency pairs, depending on the time of day and overall environment.

In general, you need to be aware that overall liquidity and market interest in these pairs is significantly lower than in the majors, although Aussie has caught up with the majors in recent years and has overtaken the CHF as the fifth most traded currency in the world. On a daily basis, liquidity in these pairs is at its peak when the local centers (Toronto, Sydney, and Wellington) are open. London market makers provide a solid liquidity base to bridge the gap outside the local markets, but you can largely forget about USD/CAD during the Asia/Pacific session, and the Aussie and Kiwi markets are problematic after the London/European session close until their financial centers reopen a few hours later. The net result is a concentration of market interest in these currency pairs among the major banks of the currency countries, which has implications of its own (see the “Technical levels can be blurry” section, later in this chapter).

Price action is highly event driven

As a result of the overall lower level of liquidity in these currency pairs, in concert with relatively high levels of speculative positioning (at times), you’ve got the ultimate mix for explosive reactions after currency-specific news or data comes out. A dovish statement from a previously hawkish Bank of Canada governor can trigger a sea change in sentiment against the CAD. If expectations are running high for an NZD interest-rate hike, and a key inflation report contradicts that outlook (it’s lower than expected), we’ve got a relatively small market, probably overpositioned in one direction (long NZD/USD), that’s all heading for the exit (selling) at the same time.

The bottom line in these currency pairs is that significant data or news surprises, especially when contrary to expectations and likely market positioning, tends to have an outsized impact on the market. Traders positioning in these currencies need to be especially aware of this and to recognize the greater degree of volatility and risk they’re facing if events don’t transpire as expected. It’s one thing if Eurozone CPI comes in higher than expected, but it’s another thing entirely if Australian CPI surprises to the upside.

A data or event surprise typically leads to a price gap when the news is first announced. If the news is sufficiently at odds with market expectations and positioning, subsequent price action tends to be mostly one-way traffic, as the market reacts to the surprise news and exits earlier positions. If you’re caught on the wrong side after unexpected news in these pairs, you’re likely better off getting out as soon as possible than waiting for a correction to exit at a better level. The lower liquidity and interest in these currency pairs mean you’re probably not alone in being caught wrong-sided, which tends to see steady, one-way interest, punctuated by accelerations when additional stop-loss order levels are hit.

All politics (and economic data) is local

Most of our discussion of market drivers centers on economic data and monetary policy, but domestic political developments in these smaller-currency countries can provoke significant movements in the local currencies. National elections, political scandals, and abrupt policy changes can all lead to upheavals in the value of the local currency. The effect tends to be most pronounced on the downside of the currency’s value (meaning, bad news tends to hurt a currency more than good news — if there ever is any in politics — helps it). Of course, every situation is different, but the spillover effect between politics and currencies is greatest in these pairs, which means you need to be aware of domestic political events if you’re trading them.

In terms of economic data, these currency pairs tend to participate in overall directional moves relative to the U.S. dollar until a local news or data event triggers more concentrated interest on the local currency. If the USD is under pressure across the board, for instance, USD/CAD is likely to move lower in concert with other dollar pairs. But if negative Canadian news or data emerges, USD/CAD is likely to pare its losses and may even start to move higher if the news was bad enough. If the Canadian news was CAD-positive (say, a higher CPI reading pointing to a potential rate hike), USD/CAD is likely to accelerate to the downside, because USD selling interest is now amplified by CAD buying interest.

Technical levels can be blurry

The relatively lower level of liquidity and market interest in these currency pairs makes for sometimes-difficult technical trading conditions. Trend lines and retracement levels in particular are subject to regular overshoots. Prices may move beyond the technical level — sometimes only 5 to 10 pips, other times for extensive distances or for prolonged periods — only to reverse course and reestablish the technical level later.

The basic reason behind this tendency to overshoot technical levels is that market interest is concentrated in fewer market-makers for these pairs — usually the local banks of the currency country. The result is a concentration of market interest in fewer hands, which can result in order levels being triggered when they may not be otherwise. For example, if you’re an interbank market-maker watching a stop-loss order for 5 million AUD/USD, it’s not a big deal, because 5 million Aussie is transacted easily. But if you have a stop loss for 50 million or 100 million AUD/USD, you’re going to need to be fast (and, likely, preemptive) to fill the order at a reasonable execution rate.

If the price break of a technical level is quickly reversed, it’s a good sign that it was just a position-related movement. If fresh news is out, however, you may be seeing the initial wave of a larger directional move.

It’s worth noting that things are changing, however, as the commodities currencies (the AUD and CAD, in particular) gain more of the FX market share of volume.

Trading the Scandies: SEK, NOK, and DKK

A few of the Scandinavian, or Nordic, countries chose not to join the monetary union that led to the euro, namely Sweden, Norway, and Denmark. Trading volumes in the Scandies are generally light, but sufficient enough to offer additional speculative trading opportunities depending on the circumstances. Most of the trading in the Scandies is done versus EUR, driven by intra-European divergences in either growth or interest rate outlooks. Generally speaking, trading the USD versus the Scandies tends to mimic EUR/USD, but in mirror image due to quoting conventions.

Swedish krona — “Stocky”

The Swedish krona is affectionately referred to as Stocky after the capital Stockholm, and its currency code is SEK. Trading volumes in USD/SEK (dollar/Stocky) and EUR/SEK (euro/Stocky) amounted to 2 percent and 1 percent, respectively, of daily global volume, according to the 2013 BIS survey of forex markets. Compared to the 2010 survey, trading volume in the SEK was down slightly in 2013, potentially due to the rising popularity of trading emerging market currencies and other majors like the Aussie dollar. The Swedish central bank, Sveriges Riksbank in Swedish, is independent and is the key actor in setting interest rates and maintaining currency stability.

In addition to following the economic data coming out of Sweden, pay close attention to comments from the governor and other Riksbank officials. The Riksbank follows an inflation target, a desired level of inflation, so CPI reports are also critical inputs to the outlook for interest rates and SEK. The Swedish central bank also has a history of speaking out on the value of the krona itself, especially when it’s either too strong or weak relative to EUR, where most of Swedish trade is conducted. EUR/SEK can become especially active when the Riksbank and the ECB are seen to be on divergent interest rate paths.

Technically speaking, after joining the European Union in 1995, Sweden is obliged to adopt the euro at some point in the future, but has effectively opted out and shows no signs of joining the euro.

Norwegian krone — “Nokkie”

The Norwegian krone (NOK) is nicknamed Nokkie after its currency code and in symphony with Stocky. USD/NOK and EUR/NOK trading volumes didn’t get broken out on the 2013 BIS survey, so they’re likely sub-1 percent of daily global volume. Still, liquidity in NOK is more than sufficient, especially during European trading hours. Norway’s central bank, Norges Bank, is independent and pursues a traditional policy of maintaining price stability. Keep an eye out for guidance from the governor and other central bank officials, as Norges Bank policy may frequently diverge from ECB policy.

Norway is exceptionally wealthy owing to its large energy reserves, mainly North Sea oil, which has given it a large sovereign wealth fund, making it an important global asset manager. More importantly for day-to-day trading, Norway is the world’s tenth largest oil producer, and NOK tends to trade as a petro-currency, similar to CAD, strengthening as oil prices rise and vice versa. Norway is not a member of the EU and so is unlikely to ever adopt the euro.

Danish krone — “Copey”

The Danish krone (DKK) is sometimes called Copey in reference to the capital of Copenhagen. Rather than pursuing currency independence like Sweden and Norway, Denmark opted to enter into a cooperative exchange rate agreement with Eurozone members, and the Danish krone is linked to the euro at a fixed exchange rate of 7.46038 +/−2.25%. Within this arrangement, the Danish central bank (Danmarks Nationalbank) effectively sets interest rates according to ECB decisions. The result is that the USD/DKK pair trades in mirror opposite fashion to EUR/USD and that the EUR/DKK pair trades in a very narrow band, typically about 0.25 percent, around the fixed rate. As such, there is little incentive for trading DKK, as EUR/USD offers better liquidity and EUR/DKK doesn’t move. In the aftermath of the Eurozone sovereign debt crisis, the Danish government has backed away from holding a referendum on Euro membership. However, the government seems happy to stick with the EUR/DKK peg for now.

Cross-Currency Pairs

A cross-currency pair (or cross, for short) is any currency pair that does not have the U.S. dollar as one of the currencies in the pairing. (Turn to Chapter 4 for a list of all the different cross pairs.) But the catch is that cross rates are derived from the prices of the underlying USD pairs. For example, one of the most active crosses is EUR/JPY, pitting the two largest currencies outside the U.S. dollar directly against each other. But the EUR/JPY rate at any given instant is a function (the product) of the current EUR/USD and USD/JPY rates.

The most popular cross pairs involve the most actively traded major currencies, like EUR/JPY and EUR/GBP. (In the past, EUR/CHF would have been in the mix, but since the 2011 peg, EUR/CHF has become less attractive to trade.) According to the 2013 BIS survey of foreign-exchange market activity, direct cross trading accounted for a relatively small percentage of global daily volume — around 7 percent for the major crosses combined, and this level has fallen since the 2010 survey.

But that figure significantly understates the amount of interest that is actually flowing through the crosses, because large interbank cross trades are typically executed through the USD pairs instead of directly in the cross markets. If a Japanese corporation needs to buy half a billion EUR/JPY (half a yard, in market parlance), for example, the interbank traders executing the order will alternately buy EUR/USD and buy USD/JPY to fill the order. Going directly through the EUR/JPY market would likely tip off too many in the market and drive the rate away from them. (We look at how large cross flows can drive the dollar pairs in the “Stretching the legs” section, later in this chapter.)

For individual traders dealing online, however, the direct cross pairs offer more than ample liquidity and narrower spreads than can be realized by trading through the dollar pairs. Additionally, most online platforms do not net out positions based on overall dollar exposure, so you’d end up using roughly twice the amount of margin to enter a position through the dollar pairs to create the same position you’d have if you’d gone through the direct cross market. The advances in electronic trading technology even make relatively obscure crosses like NZD/JPY and GBP/CHF easily accessible to individual online traders.

Why trade the crosses?

Cross pairs represent entirely new sets of routinely fluctuating currency pairs that offer another universe of trading opportunities beyond the primary USD pairs. Developments in the currency market are not always a simple bet on what’s happening to the U.S. dollar. Crosses are the other half of the story, and their significance has increased as a result of electronic trading. Years ago, if you wanted a price in a cross pair, a human would have to push the buttons on a calculator to come up with the cross quote. Today’s streaming price technology means that cross rates are as fluid as the dollar pairs, making them as accessible and tradable as USD/JPY or EUR/USD.

In particular, cross trading offers the following advantages:

• You can pinpoint trade opportunities based on news or fundamental trends. If the outlook and data for the UK is steadily deteriorating, you may be looking to sell GBP. But against what? If the USD is also weakening, buying USD and selling GBP may not yield any results. Selling GBP against another currency with better immediate prospects (such as selling GBP/CAD or GBP/NOK) may yield a more appreciable return.
• You can take advantage of interest-rate differentials. Selling low-yielding currencies against higher-yielding currencies is known as a carry trade (see Chapter 10). Carry trades seek to profit from both interest-rate differentials and spot price appreciation, and can form the basis of significant trends.
• You can exploit technical trading opportunities. The majors may be range bound or showing no actionable technical signals, but a cross rate may be extremely volatile and could provide a nice price breakout. Survey charts of cross rates to spot additional technical trading setups.
• You can expand the horizon of trading opportunities. Instead of looking at only four to seven dollar pairs, cross rates offer another dozen currency pairs that you can look to for trading opportunities.
• You can go with the flow. Speculative flows are ever-present in the currency market, but they don’t always involve the dollar pairs. Today’s speculative flow may be focused on the JPY crosses or selling CAD across the board on the back of surprisingly weak CAD data. The more attuned you are to cross-currency pairs, the more likely you are to identify and capitalize on the speculative move du jour.

Stretching the legs

A lot of interbank cross-trading volume does not go through the direct cross market, because institutional traders have a vested interest in hiding their operations from the rest of the market. In many cases, too, standing liquidity is simply not available in less-liquid crosses (GBP/JPY or NZD/JPY, for example). So they have to go through the legs, as the dollar pairs are called with respect to cross trading, to get the trade done. They also have an interest in maximizing the prices at which they’re dealing — to sell as high as possible and to buy as low as possible.

One of the ways they’re able to do that is to alternate their trading in the dollar legs. For instance, if you have to sell a large amount of EUR/JPY, you can alternate selling EUR/USD, which may tend to drive down EUR/USD but also push USD/JPY higher (because U.S. dollars overall are being bought). You now (you hope) have a higher rate at which to sell the USD/JPY leg of the order. But selling USD/JPY may push USD/JPY lower or cap its rise, leading EUR/USD to stop declining and recover higher, because U.S. dollars are now being sold. Now you have a slightly better EUR/USD rate to keep selling the EUR/USD leg of the order. By alternating the timing of which U.S. dollar leg you’re selling, you have (you hope) executed the order at better rates than you could have directly in the cross and likely managed to obscure your market activity in the more active dollar pairs.

Of course, it doesn’t always work out as neat and clean as what we just described. The net result in the market is a steady directional move in the cross rate, while the USD pairs remain relatively stagnant or within recent ranges. Be alert for such dollar-based movement, and consider that it may be a cross-driven move and a potential trading opportunity.

Cross-rate movements can also have a pronounced effect on how individual dollar pairs move in an otherwise dollar-based market reaction. Let’s say some very USD-positive news or data has just been released, and the market starts buying USD across the board. (We focus on buying USD/JPY and selling EUR/USD in this example.) If USD/JPY happens to break a key technical resistance level, it may accelerate higher and prompt EUR/JPY to break a similarly significant resistance level, bringing in EUR/JPY buyers. The net effect in this case is that EUR/USD will not fall as much or as rapidly as USD/JPY will rally, because of the EUR/JPY cross buying. If you went short EUR/USD on the positive U.S. news, you may not get as much joy. But the legs also tend to move in phases, and continued EUR/USD selling may eventually break through support, sending EUR/JPY lower and capping USD/JPY in the process.

As you can see, crosses can affect the market in virtually limitless ways, and there’s no set way these things play out. Luckily, with the onset of online trading, you don’t have to work out cross trading in the same way the guys did in the olden days! However, it’s still interesting to find out how it was done and see how the dynamics of the market actually work.

When the U.S. dollar is not the primary focus of the market’s attention, or if major U.S. news is approaching (like a nonfarm payrolls [NFP] report or a Federal Open Market Committee [FOMC] decision in a few days), sending market interest to the sidelines, speculative interest frequently shifts to the crosses. Always consider that the market’s focus may be cross-driven rather than centered on the USD or any other single currency. Some days it’s a dollar market, and other days it’s a cross market. GBP may be weakening across the board on weak U.K. data, but if the USD is similarly out of favor, the pound’s weakness is likely to be most evident on the crosses.

When looking at cross-trade opportunities, you may be tempted to translate the cross idea into a USD-based trade. You may think that AUD/JPY is forming a top, for example. If you’re right, you may be thinking that one of two moves is likely — USD/JPY will move lower or AUD/USD will move lower — and you may be tempted into selling one of the legs (AUD/USD or USD/JPY) because you don’t want to get involved in a cross. But there’s another possibility: One leg may go down precipitously while the other moves higher, still sending the cross lower as you expected. But if you went short the wrong leg, you missed the boat.

When you spot a trade opportunity in a cross, trade the cross. Don’t try to outguess the market and pick which component will make the cross move. Trust that if your trade analysis is correct, the cross will move the way you expect. And with the onset of electronic trading, it has never been easier to trade the crosses.

Trading the JPY crosses

The JPY crosses constitute one of the primary cross families and basically pit the JPY against the other major currencies. EUR/JPY is the highest volume of the JPY crosses, but the prominence of the carry trade, where the low-yielding JPY is sold and higher-yielding currencies are bought, has seen significant increases in AUD/JPY and NZD/JPY trading volume. Those currencies offer the highest interest-rate differentials against the JPY.

JPY crosses have their pip values denominated in JPY, meaning profit and loss will accrue in JPY. The margin requirement will vary greatly depending on which primary currency is involved, with GBP/JPY requiring the greatest margin and NZD/JPY requiring the least.

In terms of JPY-cross fundamentals, risk sentiment (see Chapter 5) and overall volatility tend to have the greatest impact, but as we caution earlier, trying to pin down which leg is going to cause the JPY crosses to move is a risky game. When trading in the JPY crosses, you need to keep an eye on USD/JPY in particular, due to its relatively explosive tendencies and its key place as an outlet for overall carry trade buying or selling. Be alert for similar technical levels between USD/JPY and the JPY crosses, as a break in either could spill over into the other.

Trading the EUR crosses

Outside of EUR/JPY, EUR cross action tends to be concentrated in EUR/GBP and EUR/CHF, where the cross direction is largely determined by changing outlooks between the Eurozone economy relative to the UK and Swiss economies. Reactions to Eurozone and Swiss news or data are most likely to be felt in the EUR crosses as opposed to EUR/USD or USD/CHF, whereas UK news/data is going to explode all over GBP/USD and EUR/GBP. Trading in EUR/SEK and EUR/NOK offers yet another way to exploit divergent economic or interest rate trajectories between continental Europe and the Scandinavian countries.

Sharp USD-driven moves will also affect these crosses, with the brunt of the USD move being felt in GBP/USD and USD/CHF, frequently biasing those legs to drive their EUR cross in the short run. That means frequently (but not always) that a sharp move higher in the USD will tend to see a higher EUR/CHF and EUR/GBP, while a rapid USD move lower will tend to see lower EUR/CHF and EUR/GBP.

The pip values of these EUR crosses will be denominated in either GBP or AUD. (EUR/CHF used to be a popular EUR cross, but since the 2011 peg was introduced by the Swiss National Bank, it has seen a dip in volume to 1.3 percent of daily trading volume, according to the 2013 BIS FX survey, down from 1.8 percent in 2010.) Typical daily ranges in the EUR crosses are relatively small on a pip basis — roughly 20 to 40 pips on average — but they’re still substantial on a pip-value basis and roughly equivalent to daily EUR/USD ranges.