Synthetic Pairs v. Currency Crosses

Some traders shy away from trading currency crosses (termed the bastard step-children of forex by babypips.com). The reasons for doing so can range from the lack of familiarity, lack of sufficient liquidity or even wide spreads.

Whilst the reasoning has its merits, the questions then arises, if a trader spots a near-simultaneous opportunity to go long GBP/USD and USD/JPY… which is better, i.e. to directly go long on GBP/JPY currency cross or in effect go long on the ‘synthetic pair’ (long GBP/USD and USD/JPY)?

Let’s work through at example.

At approximately 04:15 GMT on Friday, 19 June ’09 an opportunity was spotted to long USD100,000 units (1 regular lot) of GBP/JPY at 157.33 (10 pips above the pair’s previous Daily PP of 157.23). At this time, USD/JPY was approximately 96.57 and GBP/USD was approximately 1.6333.

Note: You need to remember to make sure that you buy the same amount of each pair.

For pairs with USD as the denominator (i.e. GBP/USD, etc.), then you would take the USD amount you want to purchase and divide it by the exchange rate:

USD100,000 (desired position size) divided by 1.6333 (current rate of GBP/USD) = 61,226 units of GBP/USD.

For pairs with USD as the numerator (i.e. USD/JPY, etc.), just purchase amount of units you want to buy because you are buying USD.

USD100,000 (desired position size) * 1 Unit = 100,000 Units

So, to buy USD100,000 worth of GBP/JPY, we purchase 61,226 units (0.6 lots) of GBP/USD and 100,000 units (1 lot) of USD/JPY.

When GBP/JPY reaches 159.15 (Daily R1) at approximately 11:15 GMT, you decide to also take profit and close your open positions at their respective Daily R1. So, would then exit USD/JPY at 96.96 and GBP/USD at 1.6477.

By going through the synthetic route, buying GBP/USD at 1.6333 and selling to close at 1.6477 would be a gain of 144 pips x 0.6 lots x USD10 pip value = USD864.00. Buying USD/JPY at 96.57 and selling to close at 96.96 would have gained 39 pips x 1 lot x USD10.36 pip value = USD403.85. The combined tally is USD1,267.85.

If you had bought GBP/JPY directly at 157.33 and sold to exit at 159.15… you would have gained 182 pips x 1 lot x USD10.36 pip value = USD1,884.64. In this specific instance, the synthetic pair ‘underperformed’ by USD616.79.

So, given the above ‘simulated’ results, one could make the case that if an opportunity is spotted to long two major pairs, i.e. synthetic pair… it may well be worth to DIRECTLY long the currency cross. And if an opportunity is spotted to short two major pairs, i.e. synthetic pair… it may well be worth to DIRECTLY short the currency cross. Plus, you’d actually reduce the margin required and be no worse off in terms of spread costs.

Anyhow, if you have any comments, thoughts and/or ideas on this subject… I’d love to hear them. :-)






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