If I told you that there was a large order in the market to buy EUR and sell GBP would you be looking to sell EURUSD and buy GBPUSD, do the opposite or step aside as the order gets executed?
We are just outsiders in the forex market
As outsiders, we are not privy to the flows in the market. Due to increased regulation, banks that are executing the orders are no longer able to pass on information. In addition, the increased use of online platforms makes it even more difficult to get information on order flows.
As a result, all we are left with is guesswork. However, the price action in major crosses, such as EURGBP, EURJPY, GBPJPY, etc., can give a clue to the order flows driving the price action in respective currency pairs. The focus of this article is on how to use this information to trade spot forex.
What is a currency cross?
Before I go on to the current trading world, let me define a currency cross.
A cross is the relationship between two currencies. It is simple algebra. There are two variables and one product that do not directly involve the dollar as that portion gets netted out. In all cases, the dollar portion is netted out and you are left with one currency vs. another with no US dollar component.
Example 1: EURGBP is calculated by EURUSD/GBPUSD = EURGBP. Let’s say EURUSD is trading at 1.0650 and GBPUSD at 1.2450. Then 1.0650/1.2450 = EURGBP .8554.
Example 2: EURJPY is calculated by EURUSD x USDJPY = EURJPY. Let’s say EURUSD is trading at 1.0650 and USDJPY at 154.60. Then 1.0650 x 154.60 = EURJPY164.65
The difference in the calculations where we divided the two currency pairs in example 1 and multiplied in example 2 is the way each currency pair is quoted vs. the US dollar.
For example, EUR and GBP are quoted as dollars per one EUR (or GBP) while USDJPY is quoted as Japanese Yen per US dollar.
However, this does not mean, as you will soon see, that the dollar is not impacted by cross trades as the market has to go into and out of the US xurrency (as the case may be) to create the cross.
No longer a dollar-centric world
When I first started trading in the forex market it was a dollar-centric world. The dollar was the center of all transactions and currencies rarely moved in opposite directions from one another. Most times currencies moved in the same direction in line with the prevailing dollar trend but not necessarily at the same pace. For example, if there was a EURGBP sell order and the dollar trend was up, both EURUSD and GBPUSD would both move down but the EURUSD might move farther and faster than the GBPUSD
Now, we no longer live in a US dollar-centric trading world but a multi-currency world. What I mean by that is while the dollar is still the dominant trading currency, cross-currency flows have become a large part of forex trading and more often than not drive the spot market. It is not unusual to see two currencies move in opposite directions direction against all currencies.
How to take advantage of crosses to trade spot forex
So, the question is how do you take advantage of cross flows, even if you do not trade the crosses directly? In other words, you do not have to trade the crosses to use them to your advantage in trading a spot currency, such as EURUSD or GBPUSD.
Let’s say there is a flow in EURGBP to buy EUR and sell GBP in a market where the overall dollar trend in both is up. By looking at EURGBP, you may assume there is buying of EURUSD and selling of GBPUSP to execute an order. In this example, the overall dollar trend is up but more so vs. the GBP than vs. the EUR. The EURUSD initially trades higher and GBPUSD tries to follow as the order gets executed. The EURUSD buying is easily absorbed as there are willing sellers as the trend is down ivs. the dollar. Once EURUSD hits resistance, the GBPUSD sell component of this flow takes over and GBPUSD falls sharply.
Why? The answer is that the market has less capacity to absorb the GBPUSD selling than the EURUSD buying to execute the buy order in EURGBP. Once the order is completed and/or EURGBP meets resistance, EURUSD will lose its cross-related bid.
If the EURUSD was in a strong uptrend and that was the dominant side, GBPUSD would have initially dipped but would not have gone that far. EURUSD demand out of this cross-flow would have then taken over and pushed it higher as that was the side where flows were less easily absorbed.
As we all know, trading rarely works like a textbook but in this simple example, you can see how crosses can give a clue to trading spot fx. They tell you what flows are going through the market in what can often look like a tug-of-war with respective currencies pulling in opposite directions. When the dollar trends are mixed, you can see currencies trade in opposite ways with the dollar only acting as an intermediary. As a general rule, one currency will have less capacity to absorb the flows and this is the side of the cross-trade that tends to be most vulnerable.
One way to confirm that there is real money driving a cross is when two currencies move in opposite directions vs. the dollar.
Real-time illustration
Here is a real-time illustration from April 19, 2024, where a move up in EURGBP has a greater impact on GBPUSD (sell) than EURUSD (buy)
EURGBPUSD MOVES HIGHER
EURUSD TESTS UPSIDE AND THEN STALLS
GBPUSD SELLING TAKES OVER
So, let’s conclude with the same question I asked initially:
If I told you that there was a large order in the market to buy EUR and sell GBP would you be looking to sell EURUSD and buy GBPUSD, do the opposite, or step aside as the order gets executed?
This just scratches the surface but should give you an idea of how to use crosses to trade spot forex.
Feel free to contact me with any questions or comments.
Jay Meisler, co-founder, global-view.com
jay@global-view.com
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