Synthetic currency pairs

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    A synthetic is created from trading two separate pairs in such a way as to effectively trade a third currency pair — a synthetic pair.

    This is usually the US dollar and allows the traders to make a currency pair out of any currencies they want to use.

    Synthetic currency pairs have a practical purpose, which is to eliminate the issue of limited liquidity from a broker or an overall market, or the absence of the actual instrument intended to be traded.

    For example, if a wanted to buy AUD/CAD, but the they were trading through did not actually have this available to trade, then the trader would be able to create a synthetic pair from two other currencies.

    In this scenario, the trader would actually buy the AUD and sell the CAD. They could accomplish this by simultaneously:

    • Buying the AUD/USD (buying the AUD and selling the USD)
    • Buying the (buying the USD and selling the CAD)

    The trader has now bought the AUD and sold the CAD and hence bought the AUD/CAD.

    Before trading synthetic pairs, it is important to consider the costs involved and assess whether it is actually worth doing.

    Trading a synthetic pair requires opening two separate positions. This increases the cost of the trade and the exposure to the account. Any interest rate differentials between the three countries involved could also have a negative impact on the profitability of the trade if it is carried overnight.

    Synthetic pairs are generally used by financial institutions that wish to put on large positions, but there is not enough liquidity in the market in order to do so. It is generally not a practical solution in the retail forex .

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