Trading Currencies Using a Synthetic Pair

One of the first steps you would take as a new currency trader is familiarizing yourself with the financial instruments that are trading in the FOREX market.  Most learn about the movements of the major currency pairs such as the euro versus the US dollar.  After understanding how the major are quoted and when they trade, investors usually look to currency crosses and minor currency pairs; easy-forex takes a look:

Synthetic Currency Pair

A synthetic currency pair is a traded instrument that is not listed or not traded by brokers and other market makers. Normally these pairs are not traded due to the lack of liquidity as a result from limited capital flows between the two respective countries. However, even though a currency pair isn’t activity traded does not mean you cannot trade it by creating it on your own. A synthetic currency pair is created when we use two alternative pairs to create a third unique currency pair.

How to Create a Synthetic Currency Pair

Most currencies are traded against the US dollar.  For example, both the Canadian dollar and the New Zealand dollar are active currency pairs.  If you want to trade these pairs against the greenback you will find sufficient liquidity during most time zones.  If you decided that you actually wanted to trade the New Zealand dollar versus the Canadian Dollar, you would find that most brokers do not list this pair.

To create a synthetic NZD/CAD currency pair, you may purchase the NZD/USD and also purchase the USD/CAD (which is selling the CAD).  You would be selling and buying the same quantity of USD and therefore be left with a synthetic currency pair. If you wanted to short the NZD/CAD you would sell the NZD/USD and also sell the USD/CAD. 

Costs

There are a number of costs that are associated with a synthetic pair that are beyond what you would normally pay with a liquid standard currency pair. As with any currency transaction there is a spread, which is your bid offer spread.  The bid/offer spread is the difference between were buyers are willing to purchase a currency pair and were sellers are willing to sell a currency pair. You would pay away this spread on each side of the transaction creating your synthetic pair.

Additionally, traders should consider the interest rate differential between the countries they are trading between. Since there are three countries involved in a synthetic currency transaction this should be monitored as it may negative or positively affect the trade’s profitability.  Furthermore, your broker might charge a commission which would likely be double relative to a single transaction.  Despite the costs, synthetic currency pairs may provide you with the opportunity to take advantage of movements in the market that are non-standard.

Risk warning: Forward Rate Agreements, Options and CFDs (OTC Trading) are leveraged products that carry a substantial risk of loss up to your invested capital and may not be suitable for everyone. Please ensure that you understand fully the risks involved and do not invest money you cannot afford to lose. Our group of companies through its subsidiaries is licensed by the Cyprus Securities & Exchange Commission (Easy Forex Trading Ltd- CySEC, License Number 079/07), which has been passported in the European Union through the MiFID Directive and in Australia by ASIC (Easy Markets Pty Ltd -AFS license No. 246566).