A synthetic currency pair is created from trading two separate currency 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 from a or an overall market, or the absence of the actual intended to be traded.
For example, if a trader wanted to buy AUD/CAD, but the broker 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 and sell the . They could accomplish this by simultaneously:
- Buying the AUD/USD (buying the AUD and selling the )
- Buying the USD/CAD (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 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 market.
