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Friday, December 31, 2010

Euro and Yen Crosses

After the U.S. dollar, the euro and yen are the most traded currencies. And like the U.S. dollar, the euro and yen are also held as reserve currencies by different countries. So this makes the euro and yen crosses the most liquid outside of the U.S. dollar-based "majors".

Trading the Euro Crosses

The most popular EUR crosses are EUR/JPY, EUR/GBP, and EUR/CHF.
News that affects the euro or Swiss franc will be felt more in EUR crosses than EUR/USD or USD/CHF.
U.K. news will greatly affect EUR/GBP.
Oddly enough, U.S. news plays a part in the movement of the EUR crosses. U.S. news makes strong moves in GBP/USD and USD/CHF. This not only affects the price of the GBP and CHF against the USD, but it could also affect the GBP and CHF against the EUR.
A big move higher in the USD will tend to see a higher EUR/CHF and EUR/GBP and the same goes for the opposite direction.
Confused? Ok ok...let's break this down.
Let's say that the US shows positive economic data causing the USD to rise. This means that GBP/USD would fall, driving the price of the GBP down. At the same time USD/CHF would rise, also driving the price of the CHF down.
The drop in GBP price would then cause EUR/GBP to rise (since traders are selling off their GBP).
The drop in CHF price would also cause EUR/CHF to rise (since traders are selling of their CHF).
Conversely, this would also work in the opposite direction if the U.S. showed negative economic data.

Trading the Yen Crosses

The JPY is one of the more popular cross currencies and it is basically traded against all of the other major currencies.
EUR/JPY has the highest volume of the JPY crosses as of February 2010.
GBP/JPY, AUD/JPY, and NZD/JPY are attractive carry trade currencies because they offer the highest interest rate differentials against the JPY.
When trading JPY cross pairs, you should always keep an eye out on the USD/JPY. When key levels are broken or resisted on this pair, it tends to spill over into the JPY cross pairs.For example, if USD/JPY breaks out above a key resistance area, it means that traders are selling off their JPY. This could prompt the selling of the JPY against other currencies. Therefore you could expect to see EUR/JPY, GBP/JPY, and other JPY crosses to rise as well.

The CAD/JPY

Over recent years, this currency cross has become very popular, becoming highly correlated with the price of oil.
Canada is second largest owner of oil reserves and has benefited with the rise of oil prices.
On the other hand, Japan is heavily reliant on the importing of oil. In fact, over 99% of Japan's crude is imported as it has almost no native oil reserves.
These two factors have caused an 87% positive correlation between the price of oil and CAD/JPY.
Read more >>

Creating Synthetic Pairs

Sometimes institutional traders can't trade certain currency crosses because they trade in such high volume that there isn't enough liquidity to execute their order.
In order to execute their desired trade, they have to create a "synthetic pair".
Let's say that an institutional trader wants to buy GBP/JPY but can't because there isn't enough liquidity. To execute this trade, they would have to buy GBP/USD and sell USD/JPY (earlier in this lesson, we learned that these pairs are called its legs).
They are able to do this because there is plenty of liquidity in GBP/USD and USD/JPY which means they can make large orders.
Legs of a synthetic pair
If you're a retail trader, and you wanted to pretend to trade like an institutional trader, then you could technically trade synthetic pairs as well. But it wouldn't be too smart.
Ever since the great Al Gore invented the internet, technology has improved to the point now that even weird crosses like GBP/NZD or CHF/JPY can now be traded on your broker's platform. Aside from having access to a larger "menu" of currency pairs to trade, the spreads would be tighter on the crosses compared to the synthetic pair you'd create.And let's not forgot about margin use! Creating a synthetic pair requires you to open two separate positions and each position requires its own margin. This locks up unnecessary capital in your trading account when you can simply trade the cross-currency and save on margin.
So unless you're trading yards (slang term for one BILLION units), forget synthetic pairs and stick to crosses. You will be savings yourself some pips (thanks to a tighter spread) as well as freeing up your capital so you can take on more trades.
Read more >>

Planning Around News and Fundamentals

If strong economic data comes out of Australia, you might want to look at buying the AUD. Your first reaction might be to buy AUD/USD.
But what if at the same time, recent data also show the United States experiencing strong economic growth? Price action of AUD/USD may be flat.
One option that you have is to match the AUD against the currency of an economy that isn't doing so well.... Hmmmm... what could you do?
Ah! Thank the forex gods for currency crosses!
Let's say you did some analysis, checked the BabyPips.com economic calendar(shameless plug!) or Pip Diddy's daily economic roundup (another shameless plug!) and you notice that the Japanese economy isn't doing so good right now.
What do you do?
Of course, like any self-respecting bully, you jump all over this opportunity and go long AUD/JPY!
Bullying
There's nothing wrong with being a bully, at least not here at the School of Pipsology.It's your job as a trader to take advantage of certain opportunities so that you can put some silver dollars into your piggy bank.
Because of currency crosses, you now have the opportunity to match the currency of the best performing economy against that of the weakest economy without having to deal with the U.S. dollar.
Read more >>

Obscure Crosses

While the euro and yen crosses are the most liquid crosses, more crosses exist don't even include the U.S. dollar, euro, or the yen! We'll call these the "Obscure Crosses"!
If we were in school - come to think of it, we actually are in school! - the major pairs would be the jocks while the obscure crosses would be the eccentric emo kids.
Emo kids
That's because most traders would rather hang out with the cool crowd than the obscure crosses!
We're talking about really weird combinations like AUD/CHF, AUD/NZD, CAD/CHF, and GBP/CHF. That's why we call them obscure crosses (duh!).
Trading in these pairs is more difficult and riskier than trading euro or yen crosses. Since very few traders trade them, transaction volume is much lower and liquidity can be difficult at times.
Due to the illiquid markets for these crosses, their prices can become quite volatile, so being stopped out on whipsaws can become a common occurrence.
Check out these screenshots of AUD/CHF and GBP/CHF:
Many spikes on AUD/NZD
You don't want to get stopped out by those nasty spikes, do you? That's why most traders usually put wider stops when trading these pairs.But judging from the choppy movement of obscure crosses, it would really be tough to catch a good trade on these pairs. Unless you're a currency cross guru like Cyclopip, of course!
Choppy zone on GBP/CHF
See what we mean?
Also, since these pairs aren't traded too much, the spreads on these pairs can be pretty big.
If you want to trade these crosses, just be ready for some wild price swings and be willing to pay the price of the massive spread!
Read more >>

Taking Advantage of Interest Rate Differential

By selling currencies whose country has a lower interest rate against currencies whose country has a higher interest rate, you can profit from the interest rate differential (known as a carry trade) as well as price appreciation.
That's like being able to get a frosted cupcake with sprinkles on top! That talks to you! Imagine how delicious that would taste!
Cupcake

Currency crosses offer many pairs with high interest rate differentials that are prime for these types of trades.

AUD/JPY on a steady uptrend
For example, take a look at the nice uptrend on AUD/JPY. If you had a long position on this pair, you would've made a hefty profit.
On top of that, the interest rate differential between AUD and JPY was huge. From 2002 to 2007, the Reserve Bank of Australia had raised rates to 6.25% while the BOJ kept their rates at 0%.
That means you made profits off your long position AND the interest rate differential on that trade!Now that'd be an awesome cash cow right there!
Flying cash cow
Later on in college (if your brain hasn't exploded with all this forex knowledge by then), we'll teach you more about carry trade. We'll teach you which ones will work and which ones won't. We'll even teach you about a lil' something called risk aversion. But that's for a later lesson.
Read more >>

Cleaner Trends and Ranges

Since a majority of the forex market will deal with the U.S. dollar, you can imagine that many of the news reports will cause U.S. dollar-based currency pairs to spike. The US has the largest economy in the world, and as a result, speculators react strongly to U.S. news reports, even if it doesn't cause a huge fundamental shift in the long run.
What this means for your charts is that you will see several "spikes" even if there is a trend emerging. This can make it harder to spot trend or range indications.
EURUSD: not so smooth ride to the top
The day to day economic activities of the U.S. can keep U.S. dollar based currencies such as EUR/USD (above) from making smooth trends.
EURJPY: very smooth
Conversely, we can see that during the same date range EUR/JPY made a much, much smoother ride to the top. This was probably due to less spikes that came from U.S. data. So as you can see, both charts showed the euro rise during the same time period, but the one without the U.S. dollar (EUR/JPY) made for a much easier trade.If you are a trend following kinda dude, then currency crosses may be easier to trade than the major pairs. It will be easier for you to spot the trend and be more confident in your entry points because you know that the these technical levels hold more than they do for the majors.
In the next section, we'll discuss how playing with crosses can also allow you to take advantage of the interest rate differentials. Now that's like a cherry on top of a sundae!
Read more >>

Crosses Present More Trading Opportunities

Over 90% of the transactions in the forex market involve the U.S. dollar. This is because the U.S. dollar is the reserve currency in the world. You may be asking yourself, "Why the U.S. dollar and not the sterling, or euro?"
Most agricultural and industrial commodities such as oil are priced in U.S. dollars. If a country needs to purchase oil or other agricultural goods, it would first have to change its currency into U.S. dollars before being able to buy the goods. This is why many countries keep a reserve of U.S. dollars on hand. They can make purchases much faster with Greenbacks already in their pocket.
Countries such as China, Japan, and Australia are examples of heavy importers of oil, and as a result, they keep huge reserves of U.S. dollars in their central banks. In fact, China has almost a trillion U.S. dollars in its reserve stockpile!
So what does this all have to do with trading currency crosses? Well since most of the world is glued to the U.S. dollar, a majority of trading speculation will be based on one question:
"Is the U.S. dollar weak or strong today?"
This one question will affect many of the most liquid currency pairs: 
The majors: GBP/USD, EUR/USD, USD/CHF, USD/JPY
The commodity pairs: AUD/USD, USD/CAD, NZD/USD
Notice that all of these pairs are tied to the U.S. dollar. This doesn't give a trader many options when most of their trading decisions are based on this one speculation.
2009 Performance of USD versus other major currencies
You can see that by trading any of the 7 most popular currencies, you are basically taking either an anti-U.S. dollar or pro-U.S. dollar stance. This one speculation affects these pairs in almost the same way across the board.
Conversely in the stock market, traders have multiple companies to choose from and are not bound to one major speculation idea.
2009 Performance of DJIA companies
With stocks, you can see that even though the overall market was positive, there are still plenty of other trading opportunities. There isn't just one kind of speculation that affects the entire basket of stocks.
Instead of just looking at the seven "major" dollar-based pairs, currency crosses provide more currency pairs for you to find profitable opportunities!
By trading currency crosses, you give yourself more options for trading opportunities because these currencies are not bound to the U.S. dollar, thus possibly having different price movement behaviors. So while the majority of the markets will only trade on anti-U.S. dollar or pro-U.S. dollar sentiments, you can find new opportunities in currency crosses.For example, all the dollar-based pairs might be trading sideways or in some uglier fashion where it would be smart to just sit on the sidelines and wait for better trade setups, but if you knew to switch your charts to look at currency crosses, you might just find trading opportunities galore!
Be different! The majority of traders just trade the majors. Now you can be part of the minority that trades the crosses.
Read more >>

What is a Currency Cross Pair?

What is a Currency Cross Pair?

A "currency cross pair", also known as "cross-currency pair" or simply as a "cross", is a pair of currencies that doesn't involve the U.S. dollar.
Back in the ancient days, if someone wanted to change currencies, they would first have to convert their currencies into U.S. dollars, and only then could they convert their dollars into the currency they desired.
Caveman exchange rate

For example, if a person wanted to change their U.K. sterling into Japanese yen, they would first have to convert their sterling into U.S. dollars, and then convert these dollars into yen.
With the invention of currency crosses, individuals can now bypass the process of converting their currencies into US dollars and simply convert it directly into their desired currency. Some examples of crosses include: GBP/JPY, EUR/JPY, EUR/CHF, and EUR/GBP.

Calculating Cross Rates

Currency Cross Calculator
Warning: This part is a little boring...unless you like numbers. It's not difficult but it can be kind of dry. The good news is that this section really isn't necessary anymore since most broker platforms already calculate cross rates for you.
However, if you are the type that likes to know how everything works, then this section is for you! And besides, it's always good to know how things work right? In this section, we will show you how to calculate the bid (buying price) and ask (selling price) of a currency cross.
Let's say we want to find the bid/ask price for GBP/JPY. The first thing we would do is look at the bid/ask price for both GBP/USD and USD/JPY.
Why these 2 pairs?
Because both of them have the U.S. dollar as their common denominator.
These 2 pairs are called the "legs" of GBP/JPY because they are the U.S. dollar pairs associated with it.
Now let's say we find the following bid/ask prices:
GBP/USD: 1.5630 (bid) / 1.5635 (ask)
USD/JPY: 89.38 (bid) / 89.43 (ask)To calculate the bid price for GBP/JPY, you simply multiply the bid prices for GBP/USD and USD/JPY.
If you got 139.70, good job! Your calculator is working properly, yipee!
To get the ask price for GBP/JPY, just multiply the ask prices for GBP/USD and USD/JPY and we get 139.82. Easy as pie!
Read more >>

What is a Currency Cross Pair?

A "currency cross pair", also known as "cross-currency pair" or simply as a "cross", is a pair of currencies that doesn't involve the U.S. dollar.
Back in the ancient days, if someone wanted to change currencies, they would first have to convert their currencies into U.S. dollars, and only then could they convert their dollars into the currency they desired.
Caveman exchange rate

For example, if a person wanted to change their U.K. sterling into Japanese yen, they would first have to convert their sterling into U.S. dollars, and then convert these dollars into yen.
With the invention of currency crosses, individuals can now bypass the process of converting their currencies into US dollars and simply convert it directly into their desired currency. Some examples of crosses include: GBP/JPY, EUR/JPY, EUR/CHF, and EUR/GBP.

Calculating Cross Rates

Currency Cross Calculator
Warning: This part is a little boring...unless you like numbers. It's not difficult but it can be kind of dry. The good news is that this section really isn't necessary anymore since most broker platforms already calculate cross rates for you.
However, if you are the type that likes to know how everything works, then this section is for you! And besides, it's always good to know how things work right? In this section, we will show you how to calculate the bid (buying price) and ask (selling price) of a currency cross.
Let's say we want to find the bid/ask price for GBP/JPY. The first thing we would do is look at the bid/ask price for both GBP/USD and USD/JPY.
Why these 2 pairs?
Because both of them have the U.S. dollar as their common denominator.
These 2 pairs are called the "legs" of GBP/JPY because they are the U.S. dollar pairs associated with it.
Now let's say we find the following bid/ask prices:
GBP/USD: 1.5630 (bid) / 1.5635 (ask)
USD/JPY: 89.38 (bid) / 89.43 (ask)To calculate the bid price for GBP/JPY, you simply multiply the bid prices for GBP/USD and USD/JPY.
If you got 139.70, good job! Your calculator is working properly, yipee!
To get the ask price for GBP/JPY, just multiply the ask prices for GBP/USD and USD/JPY and we get 139.82. Easy as pie!
Read more >>

Market Reaction

There's no one "All in" or "Bet the Farm" formula for success when it comes to predicting how the market will react to data reports or market events or even why it reacts the way it does.
You can draw on the fact that there's usually an initial response, which is usually short-lived, but full of action.
Later on comes the second reaction, where traders have had some time to reflect on the implications of the news or report on the current market.
It's at this point when the market decides if the news release went along with or against the existing expectation, and if it reacted accordingly.
Was the outcome of the report expected or not? And what does the initial response of the market tell us about the bigger picture?
Answering those questions gives us place to start interpreting the ensuing price action.

Consensus Expectations

Surprised woman
A consensus expectation, or just consensus, is the relative agreement on upcoming economic or news forecasts. Economic forecasts are made by various leading economists from banks, financial institutions and other securities related entities.
Your favorite news personality gets into the mix by surveying her in-house economist and collection of financial sound "players" in the market.
All the forecasts get pooled together and averaged out, and it's these averages that appear on charts and calendars designating the level of expectation for that report or event.
The consensus becomes ground zero; the incoming, or actual data is compared against this baseline number. Incoming data normally gets identified in the following manner:
  • "As expected" - the reported data was close to or at the consensus forecast.
  • "Better-than-expected"- the reported data was better than the consensus forecast.
  • "Worse-than-expected" - the reported data was worse than the consensus forecast.
Whether or not incoming data meets consensus is an important evaluation for determining price action. Just as important is the determination of how much better or worse the actual data is to the consensus forecast. Larger degrees of inaccuracy increase the chance and extent to which the price may change once the report is out.
However, let's remember that forex traders are smart, and can be ahead of the curve. Well the good ones, anyway.
Many currency traders have already "priced in" consensus expectations into their trading and into the market well before the report is scheduled, let alone released.
As the name implies, pricing in refers to traders having a view on the outcome of an event and placing bets on it before the news comes out.The more likely a report is to shift the price, the sooner traders will price in consensus expectations. How can you tell if this is the case with the current market?
Well, that's a tough one.
You can't always tell, so you have to take it upon yourself to stay on top of what the market commentary is saying and what price action is doing before a report gets released. This will give you an idea as to how much the market has priced in.
A lot can happen before a report is released, so keep your eyes and ears peeled. Market sentiment can improve or get worse just before a release, so be aware that price can react with or against the trend.
There is always the possibility that a data report totally misses expectations, so don't bet the farm away on the expectations of others. When the miss occurs, you'll be sure to see price movement occur.
Help yourself out for such an event by anticipating it (and other possible outcomes) to happen.
Play the "what if" game.
Ask yourself, "What if A happens? What if B happens? How will traders react or change their bets?"
You could even be more specific.
What if the report comes in under expectation by half a percent? How many pips down will price move? What would need to happen with this report that could cause a 40 pip drop? Anything?
Come up with your different scenarios and be prepared to react to the market's reaction. Being proactive in this manner will keep you ahead of the game.

What the Deuce? They Revised the Data? Now what?

Too many questions... in that title.
But that's right, economic data can and will get revised.
That's just how economic reports roll!
Let's take the monthly Non-Farm Payroll employment numbers (NFP) as an example. As stated, this report comes out monthly, usually included with it are revisions of the previous month's numbers.
We'll assume that the U.S. economy is in a slump and January's NFP figure decreases by 50,000, which is the number of jobs lost. It's now February, and NFP is expected to decrease by another 35,000.
But the incoming NFP actually decreases by only 12,000, which is totally unexpected. Also, January's revised data, which appears in the February report, was revised upwards to show only a 20,000 decrease.
NFP table and revisions
As a trader you have to be aware of situations like this when data is revised.
Not having known that January data was revised, you might have a negative reaction to an additional 12,000 jobs lost in February. That's still two months of decreases in employment, which ain't good.
However, taking into account the upwardly revised NFP figure for January and the better than expected February NFP reading, the market might see the start of a turning point.
The state of employment now looks totally different when you look at incoming data AND last month's revised data.
Be sure not only to determine if revised data exists, but also note the scale of the revision. Bigger revisions carry more weight when analyzing the current data releases.
Revisions can help to affirm a possibly trend change or no change at all, so be aware of what's been released.
Read more >>

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