Learn To Trade The Crosses
Finding the right currency pair to trade should be of utmost importance to you as an individual trader. As an individual trader you will only have $1000 to $10,000 at the most as equity in your trading account. Opportunity cost is a real cost for most individual traders. Funds committed to anyone position are funds that cannot be used for in other possibly more profitable trades.
In forex trading, almost all the currency pairs are linked to one another, one way or the other. As an individual trader, if you only trade US dollar, you risk missing promising trades and opportunities offered by other currency pairs.
Most of the trading 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 tell you which currency pair is the best to trade.
What are the crosses, you may ask? Currency pairs that do not involve the dollar are known as Crosses such as EUR/AUD, CHF/GBP, EUR/JPY, EUR/GBP etc. Almost 90% of the currency pairs that are actively traded in the forex markets involve the US dollar. In simple terms, over 90% of the all the currency trades have US Dollar on one side of the trade. So what is so special about a cross?
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 good to look at the sector specific indices like health, energy, transport, education, technology. Find the most promising sector among them. Once you have identified a promising sector, you should look within that sector. Find the most promising companies that are expected to perform well over the coming months and buy their stocks. This big to small thinking is very solid. You need to think in the same manner while trading currencies.
Movements in crosses should never be overlooked as they can often hide the footsteps of large players. For example, a major investor like Warren Buffet may be bullish on Euro due to some fundamental reasons. He may try to fly under the radar and buy Euros against Pound Sterling, Swiss Francs, and Yen etc. Warren Buffet is sometimes heavily involved in currency trading when he senses an opportunity. He has sometimes been successful and sometimes unsuccessful.
Crosses movements are extremely important to swing or momentum traders as forecasting tools. They use it to predict which currencies lead the pack. If you ignore the crosses, you will be often stuck with currency pairs that do not move much.
Limited funds in your account means you should always try to choose the currency pair that is expected to move the most. But, how exactly can you come to a reasonable conclusion? By taking a look 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.
Since you have limited funds, which currency pair is the best to chose? Any EUR/USD selling pressure is likely to be offset by the buying pressure of EUR/GBP. GBP/USD sales will likely to be amplified by the cross sales EUR/GBP.
Since, EUR/GBP is rising; it would be better to short British Pound instead of Euro. This means you should short the pair GBP/USD; the chances are you will make many pips. If we had randomly picked one of the two currency pairs for shorting, we may have missed a good opportunity.
