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My question applies only to cross currency pairs. As an example, imagine my home currency (the currency I am buying with) is USD, and I intend to buy 5 units of the EUR/GBP currency pair. To keep the example simple, let's also assume zero-spread trade and no commissions whatsoever. In order to do this, I have to first convert my USD to GBP using its exchange rate. Let's say, at the moment the order takes place, the GBP/USD exchange rate is 1.39853 and the EUR/GBP exchange rate is 0.86063.

5.00000 EUR -> 4.30315 GBP -> 6.01808 USD

I need to spend 6.01808 USD to buy 5.0000 EUR.

A day passes by and I decide I want to sell back the 5 units of EUR/GBP I previously bought. The EUR/GBP rate has gone up by 2 pips at the time the sell order is put, landing at 0.86083, but the GBP/USD rate has gone down by 15 pips, landing at 1.39703. Using the new rates, the conversions look like this now:

5.00000 EUR -> 4.30415 GBP -> 6.01303 USD

As seen, even though I made a profit from the cross currency pair, as I got back more GBP than I initially spent on the trade, I actually ended up at a loss because the GBP/USD rate went down much more than the EUR/GBP went up, leading to a 0.00505 USD loss.

I would like to know if my example makes sense and if this is a real issue when has to take into account when doing cross currency trading.

2 Answers 2

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Yes, as you're exposed to two currency pairs: USD/EUR and EUR/GBP. Absent any trading costs/arbitrage opportunities, this is the same as trading USD/GBP directly.

While EUR/GBP can go up or down, you'll still need to convert your P&L into your reporting currency, which is USD. This really isn't any different from using USD and buying FTSE shares in GBP or DAX shares in EUR.

Unless you assume the EUR/USD exchange rate is fixed or somehow lock it in, you can lose from those fluctuations as well.

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  • Even though, as you say, this can happen with stocks too when buying with a different currency from your base one, it could also be argued that an increase in a stock's price will always outmatch the decrease of a currency rate, so it is not as much of a problem there. Does it make sense, though, to assume, when buying a cross currency pair, the risk is higher (both for losses and profits) and one needs to keep an eye and analyse both rates before investing? Is that the usually taken approach? Apr 19, 2021 at 23:20
  • @Tiago Silva what makes you think that FX fluctuations are small compared to stock returns? I suggest you take a look at the range of EUR/USD over the last few years...
    – 0xFEE1DEAD
    Apr 20, 2021 at 0:15
  • "Yes, as you're exposed to two currency pairs: USD/EUR and EUR/GBP. Absent any trading costs/arbitrage opportunities, this is the same as trading USD/GBP directly." Shouldn't that be USD/GBP, EUR/GBP, and USD/EUR respectively?
    – nanoman
    Apr 20, 2021 at 1:02
  • @0xFEE1DEAD nothing really. I just thought that. I am new to investing. it sounds like buying assets using a currency different from the home one can be quite complex. my last question would be, then, do brokers tend to support having multiple "wallets" in different currencies? that way I could have, for example, a EUR wallet, use that to buy european stocks and currency pairs with EUR, and, in the future, when I think the exchange rate between EUR/USD is looking good, I could convert my EUR gains back to my USD wallet Apr 20, 2021 at 9:03
  • @TiagoSilva yes, some brokers offer accounts in different currencies. If you're new to investing, I would stay away from FX speculation. It's a zero-sum game with slim margins and it's easy for retail traders to lose money.
    – 0xFEE1DEAD
    Apr 20, 2021 at 17:57
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In the scenario described, you are not actually trading the EUR/GBP pair. You're simply long EUR; this is implicitly with respect to your home currency, USD. (GBP plays no role in your trade other than a redundant and wasteful intermediate currency conversion.) To trade the EUR/GBP pair, you should also be short GBP (hold a negative GBP balance, i.e., borrow in GBP).

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  • I agree the extra conversion is unnecessary. I was just putting it out there to see if it made sense and if it was a real thing one would have to take into account when trading currency pairs without one's home currency. Just like @0xFEE1DEAD pointed out, this same problem is present when buying stocks using a different currency than the home one Apr 20, 2021 at 9:07

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