The Capabilities And Drawbacks Of Trading Cross Currency
Cross currency in Forex trading terminology is a currency pair without the U.S
. dollar. In foreign exchange market, trading is done in different currency pairs such as GBP/JPY (British pound-Japanese yen), USD/JPY (U.S. dollar-Japanese yen), USD/CHF (U.S. dollar-Swiss franc), etc. The pairing of these currencies differs significantly. There are currency pairs that include U.S. dollar while others do not.
In the Forex market, it is commonplace to first exchange other foreign currency to U.S. dollars prior to starting trading. This is what happens in most cases in Forex trading. However, this is not required when trading cross currency. A trader is therefore not mandated to first exchange other currencies into U.S. dollar before he can be allowed to trade. This process created several benefits that as discussed below.
Benefits Of Trading Cross Currency
1. It Eliminate The Need To Convert Currency
The most ultimate benefit of trading cross currency is its elimination of the need to convert other currencies into U.S. dollar before being allowed to trade. The design of this technique is to completely bypass this conversion need which is the primary cause of many inconveniences to majority of Forex traders. Previously, it was a must for a trader to first make his conversion into U.S. dollar and also later converts back to his original currency resulting in severe inconvenience and also substantial loss of currency value.
2. Potential High Trades
The Forex trader enjoys great opportunity to make several wide range trades simply by trading cross currency. These trades are of course in different currencies. The process has also significantly eliminated the general exposure of trader to the impact of U.S. dollar fluctuation due to these series of currency conversions. There is serious impact of the movement of the U.S. dollar on major currencies such as euro, Swiss franc, British pound, and Japanese yen. These four currencies will only be profitable when the U.S. dollar is considerably weak.
3. Elimination Of U.S. Dollars Effects
As said early, all world currencies are affected by the fluctuations or movements of the U.S. dollar prices. This effect extends even to the major world currencies including the British pound, euro, Swiss franc, and Japanese yen. Eliminating the need to convert these currencies into U.S. dollar before trading protects them from the effects caused by movement of the U.S. dollar prices. In fact, the U.S. dollar has significant effect on all the major world currencies. They become profitable only at the times when the U.S. dollar is weak.
4. Profitable Trading Due To Non-Dependency On U.S. Dollar Performance
There is profitable trading resulting from this technique. The performance of your trading does not at any time depends on the movements of U.S. dollar. All the traders have the ultimate opportunity to be profitable by trading cross currency which is irrespective of the performance of U.S. dollar. This trading technique is now used as a better gauge for determining the gain in strength of other currencies over U.S. dollar.
5. Lower Price Fluctuations
Fluctuations affect every world currency. It is this movement in prices that further leads to profits and loss while trading in the Forex market. Generally, you are exposed to lower price fluctuations when trading cross currency as compared to trading currency pairs that are constituted by U.S. dollar. This has a general effect of making cross currencies more stable thus beneficial to all new Forex traders. This also prevents you from the overwhelming effects of price fluctuation caused by the U.S. dollar movements.
Disadvantages Of Trading Cross Currency
1. Highly Insecure Markets
Generally, trading cross currency has little drawbacks. We can only talk about two drawbacks of this trading technique. First is its ability to create a highly insecure market. This happens because the technique is characterized by high volumes of trades which often lack a base currency for determining the overall price movements.
2. Financial And Political Instabilities
There is growing concern over political and financial stability of most countries. The underdeveloped and developing countries are the most affected. The political and financial situations in these countries can change suddenly at any time causing strong impacts on the currency pairs. This subsequently makes trading such currency risky.
Conclusion
Historically, Forex transactions were carried out only in US dollar. This necessitated the Forex traders to first convert the non-US currencies into US dollars before they can proceed with the trading. However with the introduction of trading cross currency, this is no longer the case; traders are allowed to trade these currency pairs without the series of conversions. This process has made the Forex trading very simple and easy. Even newbies in the Forex market can trade easily without much loss. The technique has also reduced the loss caused by fluctuation of U.S. dollar.
by: Ownen Moore
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