By Darrell Martin
In the first article of this series, Exotic Currencies were introduced. In Part 1, the topic of Going Long was discussed using the created synthetic pairs. In Part 2, it will be explained how to place the proper trade combinations in order to go short.
Hopefully, if you’ve read the other two articles, you are advanced enough in your trading that this is making sense to you, and you are excited about how this works. As a review, remember that if the currency you want is on opposite sides of your equation, you multiply; if it’s on the same side, you will need to divide. Let’s do a few examples.
Sell Sell AUD USD = AUD
USD x CHF CHF
In order to create the AUD/CHF and go short, you would need to sell the AUD/USD and sell the USD/CHF. That would make you short the AUD and long on that contract of the USD. On the other contract, you would be short the USD which would cancel out the first one and short the CHF thus creating a short AUD/CHF trade.
What about creating the EUR/AUD and then shorting that instrument? To start with, you would need the EUR/USD and the AUD/USD. At first glance, you probably noticed that the currencies you want are on the same side signalling that you must divide. Here’s the formula:
Sell Buy EUR / AUD = EUR USD USD AUD
When you sell the EUR/USD, you are short the EUR and long the USD. When you buy the AUD/USD, you are long the AUD and short the USD which cancels out the USD leaving you short the EUR/AUD, exactly the way you want to be for this trade.
Let’s put some numbers in this example to help you understand how that figures into the trading picture. EUR/USD is trading at 1.2516. AUD/USD is at 0.8697. When you divide 1.2516 by 0.8697 your quotient is 1.43912 which is the price of the EUR/AUD.
How about one more? Let’s short the CAD/CHF.
Here’s the formula:
Buy Sell USD / USD = CAD CAD CHF CHF
By buying the USD/CAD, you are long the USD and short the CAD. Then you sell the USD/CHF, which cancels out the USD because it is short and you are long the CHF. You are left with the short synthetic pair of CAD/CHF. The numbers for this example are USD/CAD is trading at 1.1248. USD/CHF is at 0.9671. 1.1248 divided by 0.9671 is 1.16306 which is the price for CAD/CHF.
Figuring your P/L is quite simple, you just have to combine the two P/Ls. For example, if you’re up on one contract and down on the other, your profit is the difference of the two numbers. If you’re down on both, your loss is the amounts added together. If you’re up on both, lucky you! Your profit is the amounts added together.
The next articles in this series will cover Synthetic Spread Trading with Iron Condors and Straddles. If you’d like to review the synthetic trading video, click HERE.
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