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Vehicle Currency & Interbank Market

  • #1
  • First Post: Dec 10, 2007 2:59am Dec 10, 2007 2:59am
I have been looking at the way "cross currencies" are traded in the retail fx market. It is widely assumed that any cross pair, that is, any pair where neither the quote currency nor the base currency are USD, is always traded with USD as the "vehicle currency". That is, if you are long GBP/JPY, the transaction is USD neutral, BUT the transaction is actually made up of a GBP/USD long and a USD/JPY long when your order hits the market.

Therefore, the GBP/JPY price is actually calculated using the two USD pairs, and there is no market where banks actually trade GBP/JPY directly. The banks have their reasons for doing this, which I won't get into, suffice it to say that doing so simplifies their lives a great deal to not need to worry about too many pairs.

There are a few questions I would like to put out there for those of you who are familiar with the inner workings of the interbank market.

1. Is it true that there really is NO OTC interbank dealer that deals in cross currencies directly?

2. If there isn't, shouldn't there be? Particularly for pairs like EUR/CHF and EUR/GBP that are widely traded?

3. If there is, there should also be some room for arbitrage, as "calculated" cross prices would often differ somewhat from their directly traded counterparts. How could a trader take advantage of said arbitrage?
  • #2
  • Dec 10, 2007 3:58am Dec 10, 2007 3:58am
Quoting fierceman
I have been looking at the way "cross currencies" are traded in the retail fx market. It is widely assumed that any cross pair, that is, any pair where neither the quote currency nor the base currency are USD, is always traded with USD as the "vehicle currency". That is, if you are long GBP/JPY, the transaction is USD neutral, BUT the transaction is actually made up of a GBP/USD long and a USD/JPY long when your order hits the market.

Therefore, the GBP/JPY price is actually calculated using the two USD pairs, and there is no market where banks actually trade GBP/JPY directly. The banks have their reasons for doing this, which I won't get into, suffice it to say that doing so simplifies their lives a great deal to not need to worry about too many pairs.

There are a few questions I would like to put out there for those of you who are familiar with the inner workings of the interbank market.

1. Is it true that there really is NO OTC interbank dealer that deals in cross currencies directly?

2. If there isn't, shouldn't there be? Particularly for pairs like EUR/CHF and EUR/GBP that are widely traded?

3. If there is, there should also be some room for arbitrage, as "calculated" cross prices would often differ somewhat from their directly traded counterparts. How could a trader take advantage of said arbitrage?
Fierceman, hi -

I am not entirely sure what you mean when you say "over the counter" interbank dealer. I trade FX through the ECN and they provide prices in crosses directly from the banks. (it doesn't mean though that there is anyone physically trading it - see answer below)

Regarding your 3rd question, the crosses are arbitrage-proof most of the time since they are automatically calculated (as you mentioned).

Take any cross on MT4 for example, like aud/jpy: multiply current aud/$ price with current $/jpy price and you get current aud/jpy price.

Or €/£: devide current €/$ price by current cable price and you get current €/£ price.

As far as I can see, ther is no room for arbitrage.

Hope this helps.

regards
daytrading
Enter Signature
  • #3
  • Edited 7:58am Dec 10, 2007 6:01am | Edited 7:58am
Quoting fierceman
I have been looking at the way "cross currencies" are traded in the retail fx market. It is widely assumed that any cross pair, that is, any pair where neither the quote currency nor the base currency are USD, is always traded with USD as the "vehicle currency". That is, if you are long GBP/JPY, the transaction is USD neutral, BUT the transaction is actually made up of a GBP/USD long and a USD/JPY long when your order hits the market.

Therefore, the GBP/JPY price is actually calculated using the two USD pairs, and there is no market where banks actually trade GBP/JPY directly. The banks have their reasons for doing this, which I won't get into, suffice it to say that doing so simplifies their lives a great deal to not need to worry about too many pairs.

There are a few questions I would like to put out there for those of you who are familiar with the inner workings of the interbank market.

1. Is it true that there really is NO OTC interbank dealer that deals in cross currencies directly?

2. If there isn't, shouldn't there be? Particularly for pairs like EUR/CHF and EUR/GBP that are widely traded?

3. If there is, there should also be some room for arbitrage, as "calculated" cross prices would often differ somewhat from their directly traded counterparts. How could a trader take advantage of said arbitrage?
Hi fierceman,

There some arbitrage because Forex is a decentralized market, so there not A interbank market but many interbank market.But if you think about using arbitrage to make money, there not so much opportunity because alot of bank already have some software to catch that automaticly. Anywya its like 1-2 pips and often the time you buy on Interbank #1 and sell on Interbank #2 the price already changed.

The reason a pair is not traded directly like GBPJPY is because of the spread,Right now on Reuters i have 2.5 pip spread on gbpusd and 0.5 for usd jpy. if i look at gbpjpy its 6 , so 6pip-3pip, you save 3 pip by not using gbpjpy directly.

Best Regards
EricFX
  • #4
  • Dec 10, 2007 6:15am Dec 10, 2007 6:15am
Quoting EricFX
Hi fierceman,

There some arbitrage because Forex is a decentralized market, so there not A interbank market but many interbank market.But if you think about using arbitrage to make money, there not so much opportunity because alot of bank already have some software to catch that automaticly. Anywya its like 1-2 pips and often the time you buy on Interbank #1 and sell on Interbank #2 the price already changed.

The reason a pair is not traded directly like GBPJPY is because of the spread,Right now on Reuters i have 2.5 pip spread on gbpusd and 0.5 for usd jpy. if i look at gbpjpy its 6 , so 6pip-3pip, you save 3 pip but not using gbpjpy directly.

Best Regards
EricFX

Hey EricFX, can you tell me how you could get the Reuters Terminal for trading the currencies? What is your broker and what is the minal deposit for that? And the leverage use?

thanks
Trainee at UBS Investment Banking
  • #5
  • Dec 10, 2007 6:41am Dec 10, 2007 6:41am
Quoting th_ngue21
Hey EricFX, can you tell me how you could get the Reuters Terminal for trading the currencies? What is your broker and what is the minal deposit for that? And the leverage use?

thanks
Hi th_ngue21,

You should call Reuters directly for that type of information , the platform cost between 1k and 8k by month depending what you need. For forex only its about 1.8k, that seem expensive but that worth the price, you have alot of thing who come with each package.You should call them for more information.

Best Regards,
EricFX
  • #6
  • Dec 10, 2007 12:57pm Dec 10, 2007 12:57pm
Quoting daytrading
I am not entirely sure what you mean when you say "over the counter" interbank dealer
I just meant OTC spot as opposed to an exchange traded futures dealer or the like. A decentralized market would be key in this strategy.

Quoting EricFX
There some arbitrage because Forex is a decentralized market, so there not A interbank market but many interbank market.But if you think about using arbitrage to make money, there not so much opportunity because alot of bank already have some software to catch that automaticly. Anywya its like 1-2 pips and often the time you buy on Interbank #1 and sell on Interbank #2 the price already changed.
Yeah I figured some big players would already be on it... I understand about there not being a single market, that's the whole reason I was interested. I trade with several brokers and I have noticed and exploited differences in price, sometimes for as much as 25 pips on some pretty large positions if you can believe it (more of a system malfunction with one of them methinks, but they never complained). I just don't have a system to work these things out. They just happen by chance if I'm staring at my screen (which is a surefire way for a man to lose his marbles btw). I was hoping that something more consistent would come along and I thought that a "calculated" vs. "directly traded" cross could be it - obviously on trades against 2 different market makers. But if the big banks are already on it, as you mentioned, then there is not much more I can do, cuz I'm sure as hell not gonna stare at my screen 24/5. That would defeat the whole purpose of why I got into this business in the first place.

Thanks for your replies.
  • #7
  • Last Post: Dec 10, 2007 10:57pm Dec 10, 2007 10:57pm
Quote
there is no market where banks actually trade GBP/JPY directly
Fierceman..... I may be misunderstanding you but Banks do trade physically/directly with each other in Gbp/Jpy and the other crosses..(Eur/Jpy is 3rd highest in volume on EBS). Eur/Gbp and Eur/Chf also have decent volume(not neccessarily on EBS)

The Scandi crosses like Euro/Sek and Euro/Nok have more volume/liquidity than $/Sek or $/Nok.

As mentioned there are sometimes Arb opportunities , and although every price is just a calculation of another price, so a feed into a retail platform may just automatically "create a price" based on these calculations. If using EBS or Reuters matching, then the trader who manually inputs his orders, can create whatever price he wants - which may be above/below the sum of the other pairs.

eg. Eur/Usd.....1.4715/16
$/Jpy.........111.69/70
Eur/Jpy .... 164.35/37

If someone is trading Eur/Jpy they could decide to take all the offers at 37 and bid 164.38 (without Eur/$ or $/Jpy having moved).... Whilst this would give the Arb opportunity and the initial reaction may be to "give" the Eur/Jpy and buy the other pairs (and if you're quick enough you may get away with it) , in my experience when you see these opportunities (in the Interbank market) it is actually often better to go with the guy bidding it up.

A Bank may choose to do the 2 legs of a cross individually, and/or at different times rather than the "cross pair" directly. This reasoning could be based on size/liquidity or just trying to get a better price.

In something like Gbp/Jpy (which doesnt have great liquidity + wider spreads on the platforms) then its more likely the 2 legs will be done individually... or they may not use a platform at all and just ask another bank to make a price - which will usually be a tighter spread than the platform shows.

Fierceman....I've just re-read your post and you seem to be asking if theres a way to arb the price differences between the interbank(directly traded) cross market and the retail (calculated) cross market?....Well, .If a misquote/incorrect price is input into the Interbank market - from which price a "retail price" is "calculated" then you could potentially arb it. (As you have said you have done). I guess there are measures in place to try and stop this happening.
Quote
How could a trader take advantage of said arbitrage?
I do know that there are certain ccy pairs and even certain times when these "opportunities" are more likely to occur...
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