Telescopic effect of Currency Pairs

I created this thread to get some ideas about the facts that I am going to present. Any ideas and questions are welcomed.

Please lets keep this thread as mature and as polite as possible.

I am always wondering what would be the best way of placing Stop Loss and Take Profit values. Also how to select the most suitable pair to trade at that moment.

I will try to give you an example to get into details.
Lets say we have the following pairs with their prices (we should always use 3 connecting circular pairs):

AUDUSD 0.7130
GBPUSD 1.5340
GBPAUD 2.1510

Now if AUDUSD gained 20 pips, the new price becomes 0.7150
If GBPUSD went down 20 pips, the new price becomes 1.5320

So what would be the price of GBPAUD? (for the example we will just use these 3 pairs, not considering the other pairs for now)
Initially it looks like GBPAUD should go down by 40 pips (AUD gained 20 pips + GBP lost 20 pips = 40 pips).

Most of us know that that is not the case.

If we use percentage ratios of gains and losses, than we come to the correct solution, as below:

AUDUSD 0.7150/0.7130 = 1.0028

GBPUSD 1.5320/1.5340 = 0.9987

So GBPAUD becomes 2.1510 * (0.9987/1.0028) = 2.1422. As you can see GBPAUD would lose 88 pips.

Now this reality creates some questions in my mind:

1. Why do we hear people saying "Use fixed 20 pips stop loss, 40 pips Take profit" for example? From the example above we can see that the sl or tp values should be very much different for each pair.
We could have used 30 pips SL for GBPUSD without being hit. But on the other hand 30 pips SL for GBPAUD would be a straight loser.
I think ATR doesn't solve this problem either to this extent, because it is dependent on recent activity.

2. When we are planning to trade a pair, should we look at the other circular 2 pairs?

3. When we do technical analysis or whatever analysis we do, should we analyze all 3 circular pairs?

4. When we are selecting a pair from the 3, should the lower risk tolerant traders pick the pair with lowest pip movement potential? (vice versa for the higher risk seekers).

5. If we believe that (above example) AUDUSD will go up and GBPUSD will go down, instead of trading AUDUSD long or GBPUSD short, should we pick the corresponding third pair with more profit potential?

The questions about circular 3 pairs could go on and on. These are the inital questions that came into my mind.

If you are interested in this subject, please give your comments, ideas, whatever comes into your mind.

Thanks for reading and have a good night for now.

Ideas, ideas, ideas

Hi
I am only new to forexfactory but thought I would reply in relation to your telescopic comment. If you have the same size GBPUSD position as you do in GBPAUD and you have the same size AUDUSD position as the AUD amount in your GBPAUD position you will end up making the same amount of money.
Using your example and rates, if you had 10 units of GBPAUD. The equivalent GBPUSD position is 10 units of GBPUSD and 21.151 units of AUDUSD. If you then make 20 pips in AUDUSD and 20 pips in GBPUSD you will make 0.02 in GBPUSD and 0.0423 in AUDUSD. when you add these together and divide by the AUDUSD rate you make the equivalent of 88 AUD pips excluding my rounding.
Thats how I work it out when I trade cross currency pairs.

In simpler terms, GA is always equal to GU divided by AU

Currency 'crosses' like GA are calculated based on the value of the two currencies v the USD, so this equation always holds true for any three circular sets of currency pairs, one can always be calculated by multiplying the other two.

Yes, very true. I just did the long way of calculation to show the details.

Thanks

Your choice of picking the third pair in this case GBPAUD are based on the 2 assumptions you have made. If the answer to your assumptions are correct, then yes.
But how often do you "know" it for sure? That's the question and to adjust your lot sizes accordingly.

I do trade these crosses, one thing I notice is these pairs become increasing volatile and thus profitable as fx right now is dominated by central bank policies right now. And there has been divergence in rates policies between BOE and RBA. So it is good option to trade these pairs.

GBPAUD = GBPUSD / AUDUSD (USD portions cancel out this way)
GBPAUD theoretical price = 1.532/0.715 = 2.14266

I think the questions about what you should or shouldn't do basically come down to your strategy. If it has a positive expectation and takes all 3 pairs into account in some way, then just do that. Maybe what you're really asking is whether there is any advantage to be had from looking at the triangular relationship.

Things we can observe:
1) Analyzing more than one pair in terms of the 3 pair arbitrage is problematic in most retail platforms due to problems with data synchronization.

2) If any of the 3 pairs is going to have a move, at least 2 of the pairs will move, and possibly all 3 pairs.

3) Let's say that you think GBP will have a trend move up. If both GBPAUD and GBPUSD are breaking out, this would be a confirmation.

4) It is possible to calculate the stronger pair among 3 but the stronger doesn't necessarily stay that way for long enough to profit.

5) If you are looking at a long trade on GBP via GBPUSD the ideal case is that GBP is the strongest currency and USD is the weakest going forward. If AUDUSD is going down then USD probably isn't the weakest and GBPAUD may be a better choice. Also, if GBPAUD breaks out before GBPUSD, it may be the stronger pair.

Exactly, thank you for your comments.

These are some of combos of circular 3 pairs. Behavior of first 2 pairs, end result of the 3rd pair. (+Pair up, - pair down)

EURUSD+, AUDUSD-, EURAUD+
EURUSD+, USDCAD+, EURCAD+
EURUSD+, USDJPY+, EURJPY+
EURUSD+, NZDUSD-, EURNZD+
EURUSD+, GBPUSD-, EURGBP+
EURUSD+, USDCHF+, EURCHF+
AUDUSD+, USDJPY+, AUDJPY+