Cross: What it is, How it Works, and Types

What Is a Cross?

The term "cross" has three primary definitions in finance:

1. The first type of cross is when a broker receives a buy and sell order for the same stock at the same price, and subsequently makes a simultaneous trade between two separate customers at that price. Variations of this are the market opening and market closing crosses.
2. The second type of cross is a foreign exchange (forex) transaction in which the non-U.S. currencies being traded are exchanged directly for each other instead of first being converted to U.S. dollars.
3. A cross may also refer to a technical analysis chart pattern, such as a golden cross or death cross.

Understanding a Cross Order

If a stockbroker receives separate orders to buy and sell at the same price at the same time, they must offer the stock in the market at a higher price than the bid. If no higher bid is available, they can execute the two deals at the same time and at the same price.

It's important to note that this process typically occurs in regulated markets where transparency and fairness are paramount. The broker must adhere to market rules and regulations to ensure that the execution of cross orders maintains market integrity and does not disadvantage any participants.

Opening and Closing Crosses

The Nasdaq gathers and posts data on all buy and sell interest in the two minutes prior to its opening; this information is referred to as the opening cross. Traders can post orders to buy at the opening price or to buy if there is an order imbalance. This dissemination of pricing interest helps to limit disruptions in liquidity.

The closing cross on Nasdaq matches bids and offers in a given stock to create a final price of the day. Traders can place orders that can be either "market at close," which means buy or sell at the official closing price or "limit at close."

In the latter case, if the price at the close is better than the specified limit, the deal will be executed at the market price. Nasdaq collects data for the closing cross between 3:50 p.m. and the closing time of 4:00 p.m.

Currency/ForEx Crosses

The U.S. dollar (USD) is the most actively traded currency in the multi-trillion-dollar daily foreign exchange market. In the past, investors or hedgers who wanted to trade a pair such as the euro vs. the yen, known as EUR/JPY, needed to do it through the dollar.

This meant that buying EUR and selling JPY required the following two steps:

1. Buy EUR and sell USD and
2. Buy the same amount of USD and sell JPY. Disadvantages of this approach include paying the bid/offer spread twice (once in each currency pair) and needing to deal for a USD amount rather than a EUR or JPY amount.

However, the dollar pairs are more actively traded than the cross, so in times of volatility or reduced liquidity, traders may still execute via the components.

The most actively traded currency crosses are the euro vs. the yen, British pound (GBP), and Swiss franc (CHF). Cross trades can be done for any spot, forward, or option transactions.

Limitations of Crosses In ForEx

Due to their narrower focus and lesser popularity compared to major currency pairs, many forex crosses have limited historical data available for analysis. This limited data can prevent your ability to conduct thorough technical analysis. This is especially true if you're trying to make a long-term strategy.

Secondly, forex crosses often exhibit lower liquidity compared to major currency pairs. This lower liquidity can result in wider bid-ask spreads and increased slippage. This makes it more tough for you to execute trades at your desired prices. This is especially true when there's heightened market volatility. Lower liquidity can also lead to increased price volatility and greater uncertainty in price movements, further complicating technical analysis and trade execution.

Country-specific factors that influence forex crosses can add complexity to technical analysis. Each currency in a forex cross is influenced by its own unique economic, political, and social factors, which may not always align with broader global trends or correlations. In short, the United States currency may have more stability compared to the currency of other countries, so the forex cross and exchange rate may have greater consistency.

Golden Crosses, Death Crosses, and Technical Analysis

Technical analysis involves the use of statistical analysis to make trading decisions. Technical analysts use a ton of data, often in the form of charts, to analyze stocks and markets. Technical traders learn to recognize these common patterns and what they might portend for the future performance of a stock or market.

A golden cross and a death cross are exact opposites. A golden cross indicates a long-term bull market going forward, while a death cross signals a long-term bear market. Both refer to the solid confirmation of a long-term trend by the occurrence of a short-term moving average crossing over a major long-term moving average.

Either cross may occur as a signal of a trend change, but they more frequently occur as a strong confirmation of a change in trend that has already taken place.

Limitations of Technical Analysis Crosses

One notable limitation of death crosses and golden crosses is their nature as lagging indicators. These crosses rely on past price data to generate signals. By the time a golden or death cross is confirmed, a significant portion of the price move may have already occurred. Consequently, traders may find themselves entering trades after the bulk of the price movement has transpired. This just reduces the overall effectiveness of the cross signal.

Golden and death crosses can produce false signals. In such market conditions, crosses may occur frequently without significant price movements following them. This phenomenon can lead to whipsaw trades, where traders enter positions based on crosses only to see the market reverse shortly thereafter. Traders may need to wait for ultimate confirmation which, by that time, may be too late to capitalize on worthwhile gains.

Another critical consideration is that golden and death crosses do not consider other factors influencing market behavior, such as market sentiment, fundamental analysis, or geopolitical events. While crosses provide valuable insights into price trends, traders should supplement their analysis with real-world events. Though the idea is that all of this information is "priced in", there may be factors worth thinking about not captured in the cross.

The Bottom Line

In finance, "cross" refers to three main concepts. First, it involves a broker executing simultaneous buy and sell orders for the same stock at the same price between different clients. Second, it denotes foreign exchange transactions Last, it encompasses technical analysis chart patterns like golden crosses or death crosses.