Exotic currencies: what you need to know
Exotic currency pairs offer traders a different avenue to realise a profit, away from the major currencies that dominate the market. However, trading exotic currency pairs can increase your risk as we explain here.
What is an exotic currency pair?
Exotic currency pairs include one major currency alongside a currency from a developing or emerging market. For example, an exotic forex pair would be formed when an exotic currency, such as the Turkish lira (TRY) or Hungarian forint (HUF), is paired with a major currency, such as the US dollar (USD) or euro (EUR).
Exotic currency pairs are affected by the same drivers that affect the price of the majors: interest rates, geopolitical instability, the strength of their country’s economy and the level of foreign direct investment in the domestic market, among others. Exotic pairs also tend to be less liquid than major currency pairs, which means that traders may choose to stick with the most popular exotic pairs to ensure greater liquidity.
List of exotic currencies
There are a whole host of exotic currencies that traders can choose from. Some exotic pairs that you can trade with IG are:
- USD/TRY (US dollar/Turkish lira)
- USD/SEK (US dollar/Swedish krona)
- USD/ZAR (US dollar/South African rand)
- TRY/JPY (Turkish lira/Japanese yen)
- EUR/TRY (Euro/Turkish lira)
- USD/CZK (US dollar/Czech koruna)
- USD/HUF (US dollar/Hungarian forint)
- EUR/CZK (Euro/Czech koruna)
- EUR/HUF (Euro/Hungarian forint)
- EUR/MXN (Euro/Mexican peso)
With IG, you can take a position on exotic currency pairs by trading CFDs. In doing so, you would be speculating of the price movements of a currency pair rather than buying or selling the currencies themselves. This enables you to go long or short, meaning that you have the potential to profit from markets that are rising as well as falling.
What you need to know before trading exotic currency pairs
There are two main things you need to be aware of before trading exotic currency pairs: they tend to be more volatile and less liquid than the majors. As an example of the lower liquidity in the exotic currency market, the EUR/USD pair made up 23.1% of all daily forex transactions in 2016. In contrast, USD/TRY made up just 1.3%.1
When a market is more volatile, it means that price movements are more frequent and possibly more dramatic than markets which are less volatile. As a result, volatility offers an opportunity to realise a profit thanks to drastic and sudden price movements, although this can also mean that there is greater risk of loss.
Less liquidity means that there is a greater risk of slippage on your positions. Slippage occurs when the price at which your order was requested is different than the price at which it was filled. Most often, this occurs because of a lack of market participants to take the other side of your order. However, the risks of slippage can be mitigated by attaching guaranteed stops and limits to your positions.
As a final point, the bid/ask spread is generally greater on exotic currency pairs when compared to their more popular counterparts such as EUR/USD or USD/JPY.
Trading strategy for exotic currencies
There are several trading strategies that are effective on the forex market, even when applied to exotic currency pairs which are known to be more volatile and less liquid than major pairs. For the purpose of this article, we have highlighted three that might be of use to you when trading exotic currencies:
A popular trading strategy for exotic currencies is trend trading, which involves identifying an overall trend for a currency pair and going either long or short depending on whether the trend is bullish or bearish.
While it relies more on technical analysis rather than fundamental analysis, trend trading can provide the quantitative data to support your decision making while speculating on the price movements of exotic currencies.
Breakout trading relies on a combination of both technical and fundamental analysis to capitalise on an asset’s price movements once it breaks through a historical level of support or resistance. The most popular chart patterns to use during a breakout are ascending and descending triangles, pennants and wedges.
One thing to remember when trading using a breakout strategy is that there is a risk that a breakout could be a false breakout.
Range trading involves trading an exotic currency pair within a set range of support and resistance. A trader will seek to profit from the peaks and troughs within the range by going either long or short, and they will often turn to chart patterns such as wedges and triangles to confirm their predictions about a market’s movements.
Trading example: comparing USD/TRY and EUR/USD
In general, the majors are less volatile and more liquid than the exotics. As an example, we have chosen to compare the monthly price movements of EUR/USD with USD/TRY. This is because EUR/USD is the heavily-traded forex pair in the world, and the USD/TRY pair is the most popular exotic currency pair.
The two charts below highlight the differences in the scale and speed of price changes for these two pairs in March 2019. Notice how the USD/TRY pair trades over a much wider price range than the EUR/USD pair.
Throughout March 2019, EUR/USD remained within the $1.12-$1.14 range, despite the tumultuous events surrounding Brexit which took place over the course of the month. In contrast, USD/TRY was constantly moving, starting the month at ₺5.37, moving to ₺5.47 on 21 March, before jumping to ₺5.76 overnight on 22 March.
Exotic currency pairs summed up
- Exotic currency pairs offer a more volatile but less liquid environment for traders
- Whether this is advantageous or not depends on a trader’s appetite for risk, and their individual trading style
- In many cases, traders choose not to hold an exotic currency pair overnight. Instead, traders will adopt a day trading approach to attempt to profit from small movements on an exotic currency pair throughout the day
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