Sometimes, institutional traders are not able to trade specific cross currency pairs because the market does not have enough liquidity to execute their orders.
In order to execute the transactions they want, they must create “synthetic currency pairs.” So, what is a synthetic currency pair?
Suppose you have done a relevant analysis and concluded that the pound is stronger and the yen is weaker. But your platform does not have the GBP/JPY currency pair, have you lost this trading opportunity? Do not! You can build a synthetic currency pair to do long GBP/JPY. General traders provide GBP/USD and USD/JPY. We can indirectly establish transactions against the GBP/JPY currency pair through the transactions of these two currency pairs. The specific methods are as follows:
While long GBP/USD, long USD/JPY, the premise is that the number of transactions must be exactly the same. Everyone knows that when we go long for GBP/USD, we actually bought GBP and sold US dollars; when we went long for USD/JPY, we bought US dollars and sold Japanese yen. In the trading of the first group of currency pairs, the US dollar sold and the US dollar bought in the second group of currency pairs cancel each other out, so the end result is actually to establish a structure of long GBP/JPY.
Traders can do this because GBP/USD and USD/JPY are quite liquid, which also means that they can place orders arbitrarily.
If you are a foreign exchange retailer and you plan to trade like an institutional trader, then technically, you can also trade synthetic currency pairs. However, you are not so smart.
With the development of Internet technology, even more bizarre cross currency pairs, such as GBP/NZD, CHF/JPY can now be traded on your broker trading platform. Except for most of the currency pairs we usually trade, the spread of trading cross currency pairs is much lower than our creative spread of synthetic currency pairs.
At the same time, we must not forget the use of margin. Synthetic trading requires you to open two separate positions, and each position requires you to invest a deposit.
Compared to synthetic trading, when you conduct simple cross currency pairs trading, you can avoid the use of unnecessary funds, thereby saving your margin.
Therefore, unless your trading unit is calculated in yards (commonly known as 1 million units), then, instead of giving up synthetic trading, choose to trade cross currency pairs instead. In this way, the spread of your expenditure is lower, and you can save more capital for more transactions.