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What is Triangular arbitrage in Forex? How to do it with cross-pairs?
What is Triangular arbitrage in Forex?
A triangular arbitrage opportunity is a trading strategy that exploits the arbitrage opportunities that exist among three currencies in a foreign currency exchange. The arbitrage is executed through the consecutive exchange of one currency to another when there are discrepancies in the quoted prices for the given currencies.
A triangular arbitrage opportunity occurs when the exchange rate of a currency does not match the cross-exchange rate. The price discrepancies generally arise from situations when one market is overvalued while another is undervalued.
Triangular arbitrage is the result of a discrepancy between three foreign currencies that occurs when the currency’s exchange rates do not exactly match up. These opportunities are rare and traders who take advantage of them usually have advanced computer equipment and/or programs to automate the process.
Currency cross pairs: how to trade them?
Did you know that trading profit opportunities are not limited to your favorite currency pairs such as EUR/USD, GBP/USD or USD/JPY? Apart from these favorite pairs, a currency pair can also be formed without the USD being involved. In this article, we will discuss about “Currency cross pairs”. You will be aware of all the opportunities presented by these pairs and understand how to trade them and how to avoid their mistakes.
What are Currency cross pairs?
After World War II ended and the gold standard deteriorated, the majority of currencies quoted against the dollar were also fixed against gold. When the public wants to exchange their money for other currencies, they must convert them into USD first before exchanging them into the desired currency. Not long after, cross pairs were created. With cross pairs, we no longer need to bother converting to dollars and can directly exchange them into the currency we want. In general, Currency cross pairs (cross currency, cross) are currency pairs in the Forex market that do not involve USD. With FBS you can trade AUD/USD, EUR/GBP, CHF/JPY, EUR/NZD and other cross pairs!
How to calculate the exchange rate of cross pairs?
The most important thing is to understand the formation of this type of currency pair. For example, the EUR/GBP pair. We need to know the bid/ask price for GBP/USD and EUR/USD to calculate the bid price for EUR/GBP. Why do we choose these pairs? That’s because they have USD as the quote currency in them.
GBP/USD: 1.2887 (bid) / 1.2889 (ask)
EUR/USD: 1.1286 (bid) / 1.1287 (ask)
To calculate the bid price for EUR/GBP, we need to divide the base currency bid by the quote currency ask:
EUR/GBP (bid) = 1.1286/1.2889 = 0.8756
For the ask price, we need to divide the base currency ask by the quote currency bid.
EUR/GBP (ask) = 1.1287/1.2887= 0.8758
Looks confusing? Most brokers, including FBS, calculate the cross value and spread size for you automatically. Therefore, you do not need to study the formula above!
Which cross pairs are better to choose?
Cross pairs can be divided into three groups.
The first group is cross pairs with major currencies (EUR, JPY and GBP). These three major currencies have good liquidity, as well as major currency pairs in general. This can be seen in the high number of traders who trade it, in addition to the possibility of a relatively low price jump. You can trade, for example, EUR/GBP, GBP/JPY, CHF/JPY.
The second group is an amalgamation of what are commonly called “obscure” currency crosses because they are traded so infrequently. In pairs, they do not involve EUR, JPY or GBP. This makes the movement very volatile or difficult to predict. Let’s take a look at the NZD/CAD chart. We can see long bullish and bearish candlesticks. The big spike will certainly be a challenge for traders to determine the next price movement. Thus, you should exercise caution when trading them, and it is advisable to carry out proper analysis.
And the last one is exotic cross pairs. These cross pairs usually come from developing country currencies. With FBS, you can trade these exotic cross pairs, such as CHN/JPY, EUR/TRY or EUR/CNH. As with the second group, you have to be careful when trading it, and don’t forget to use stop losses.
Why should you trade currency cross pairs?
You can trade fundamentally more easily.
If the release of important news for the EUR pushes the EUR up and the USD strengthens, it could result in the price on the EUR/USD being flat or flat. Cross pairs can help you take advantage of the EUR. However, you should still monitor all the political and economic dynamics of the countries whose currencies you trade. Any disinformation can bring you a loss.
In the image below, weak news for the US dollar and positive news for the euro suggest an equal balance of power between bulls and bears, thus making the pair trade sideways. As a result, it is difficult to define and follow current trends.
Next, take a look at the EUR/GBP chart. As is known, the UK economy is in turmoil amid Brexit uncertainty. That’s why the EUR has become stronger than the GBP. We see that the trend in this pair will tend to rise (uptrend), because EUR is pushing the pair to go higher. Therefore, we capitalize on positive releases from the eurozone
You can earn incentives from interest rate differentials (Carry Trade strategy)
You can make money by selling a currency with a lower interest rate against a currency whose country has a higher interest rate. This strategy is often known as the Carry Trade strategy.
They help in trading major currencies
Currency cross pairs help you identify the relative strength of each of the major currency pairs. Suppose you see buy signals for EUR/USD and GBP/USD, but you can only trade one currency pair. The results of the EUR/GBP cross pair analysis will help you determine the right buy position. If the trend of the pair is bullish, then the EUR will look relatively stronger than the GBP at the moment. So you need to buy EUR/USD, not GBP/USD. Because the GBP is weaker than the EUR, and if it strengthens against the USD, it will strengthen less than the EUR. As a result, EUR/USD will rise higher than GBP when the USD weakens.
Example
In the EUR/USD and GBP/USD charts below, we observe that the MACD has formed a bullish divergence, which indicates a pretty good buying signal. However, we only need to choose one currency pair here.
We decided to test EUR/GBP with other indications. The pair is moving up. That is, the EUR is stronger than the GBP. If this currency strengthens, you will make more pips trading EUR/USD than GBP/USD.
Now you see that trading cross pairs can not only be used as a way for a trader to appear more “hipsterish”. Trading cross pairs helps you understand every movement in the market thoroughly, gives you the opportunity to trade one currency against another directly and offers more opportunities to make money.
