Does USD price affect foreign forex cross trades?

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LeviF
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Does USD price affect foreign forex cross trades?

Post by LeviF » Thu Apr 24, 2008 8:05 pm

My home currency is USD. If I trade a cross that doesn't have USD in it, like EUR/JPY, does the movement of USD affect the profitability of the trade? Part of me seems to think that movement of USD would cancel itself out in a foreign cross, but another part of me thinks that because USD is my home currency, its movement does matter...

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Post by LeviF » Thu Apr 24, 2008 10:56 pm

I ran some tests and the answer is yes, the home currency does affect performance. I tested the USD vs. EUR on non-US and non-EUR crosses. The results were pretty similar, but different nonetheless. Now i guess the question is should a person trade the foreign crosses. If I can trade GBP/USD and USD/JPY, then why do I need to trade GBP/JPY...

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Post by sluggo » Fri Apr 25, 2008 5:20 am

Perhaps you may find value in Jake Carriker's and nickmar's random portfolio Blok, posted on this site. (sorry I don't have the exact place, you'll need to search). You could try four thousand different random portfolios of USD/XXX crosses, four thousand different random portfolios of YYY/ZZZ crosses (no USD allowed), and four thousand different random portfolios containing both USD/XXX and YYY/ZZZ. Then you could see which of the three has the largest mean return, the largest median return, the greatest ratio of (median / standard deviation), and so forth.

When I did this myself on futures, after looking at the results I decided I preferred to have both the USD-denominated "cross rate futures" (like the standard CME-IMM futures USD/CHF, USD/EUR, USD/JPY) and also non-USD "cross rates" (like the FINEX cross rate futures EUR/JPY, EUR/CHF, GBP/JPY, and so forth see (link)). But you may have a different preference after studying the data yourself.

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Post by LeviF » Fri Apr 25, 2008 6:40 am

From the tests I have run, the portfolio including the foreign crosses performs better than the one with only USD rates. But, when I ran my USD and EUR base currency tests, the USD base had performed better. I assume that is because the EUR has been a stronger currency than the USD. The profitability of the non-US crosses is still subject to the trend of the USD since that is my home currency. Logically, it seems that I shouldn't trade the non-US crosses because an important part of the profitability (USD price) is not taken into consideration...

If you had ran your random portfolio test with a base currency of EUR, you may have struck a different conclusion...

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Post by LeviF » Fri Apr 25, 2008 12:53 pm

On the other hand, maybe I should just view the foreign crosses the same as any other instrument? I can take my USD and buy GBP, I can take my USD and buy gold or oil, I can take my USD and buy real estate, or I can take my USD and buy an AUD/CAD cross. What's the difference?

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Post by LeviF » Sat Apr 26, 2008 9:15 am

Maybe I'm wrong, because those other instruments are all priced in USD. Foreign crosses are not...

This is the equivalent of thinking out loud for me. If anyone has any input, please share!

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Re: Does USD price affect foreign forex cross trades?

Post by gunter » Mon Apr 28, 2008 9:22 am

levijean wrote:My home currency is USD. If I trade a cross that doesn't have USD in it, like EUR/JPY, does the movement of USD affect the profitability of the trade? Part of me seems to think that movement of USD would cancel itself out in a foreign cross, but another part of me thinks that because USD is my home currency, its movement does matter...
Based on my observations on the GBP/JPY cross, I can add the following.

You could do some calculations on OANDA's calculators. Based on the formula they use in the calculator you could use either the EUR/USD or USD/JPY to calculate your profit in USD.

To get to the EUR/JPY cross, we would use EUR/USD x USD/JPY. However, I found that this ratio does not always equal the EUR/JPY quoted (don't know why, don't think it matters too much).

If you would thus buy the EUR/JPY, and the USD weakens, this would increase the profit on the individual transaction, however the USD that we receive once we exit the deal would be worth less. Thus theoretically the underlying movement in the USD does not affect the EUR/JPY trade.

The reasoning above makes sense to me, but I could be wrong.

You could play around a bit with the profit calculator at OANDA and Excel. OANDA uses the EUR/JPY to calculate their profit, but you could also use the EUR/USD. I found that playing with the formulas made it easier to understand their exact workings and the relationship of the cross.

Cheers

gunter

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Post by gunter » Mon Apr 28, 2008 9:30 am

levijean wrote:I ran some tests and the answer is yes, the home currency does affect performance. I tested the USD vs. EUR on non-US and non-EUR crosses. The results were pretty similar, but different nonetheless. Now i guess the question is should a person trade the foreign crosses. If I can trade GBP/USD and USD/JPY, then why do I need to trade GBP/JPY...
In my trading account all the above forex rates are included in the system. I have found that in periods where the GBP/USD and USD/JPY might be flat, the GBP/JPY could be in the market. To me, trading the cross adds some diversification, as its movement is not similar to either of the other pairs.

From a trading standpoint (if we only look at the final USD number) it definitely makes more sense to include some crosses if this increases profitability of the system. This, however, can still be affected by movements in the USD as I might find that my dollars become worth less in the end (if this is a concern, you could always hedge your account).

Cheers

gunter

Edit: You could also find that if you keep the total portfolio-level risk constant, that adding the crosses could potentially reduce drawdowns while keeping the profits similar.

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Post by jungle » Wed May 07, 2008 12:16 pm

to clarify:

a "pair" is two currencies, one of which is USD

a "cross" is two non-USD currencies

re: the original q, "If I trade a cross that doesn't have USD in it, like EUR/JPY, does the movement of USD affect the profitability of the trade?"

that depends on your numeraire currency (i.e. if that's USD, then the non-USD PNL from your EURJPY posy has to be converted to USD).

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