Exotic forex pairs are the most thinly traded currency pairs. They involve one major currency (currencies belonging to the G7 nations) and a currency of a developing nation. Despite the low volume, exotics are a popular forex trading asset among some traders. Read on to find out what drives them and some strategies that help trading exotic currencies.
The exoticism of a forex pair is in no way a reflection of the relative price of the currency or state of the economy of the country to which it belongs. It simply means that the trading volume of the pair is much lower, often less than 2% of the total daily volume in the global forex market. Despite their low volume, trading exotic currencies offers several benefits. Here’s a look at these.
Exotic pairs are often more volatile than major or minor forex pairs. This means their price interest point (pip) movement is much higher than that of their major peers, which enhances the potential profit from a winning trade.
For instance, consider the EUR/USD pair. It may move from 1.3026 to 1.3027 or to 1.3025, both of which involve the pip movement of 0.0001. On the other hand, an exotic pair like EUR/NZD may move from 175.54 to 175.55 or 175.53, which makes the pip 0.01 (which is 100x higher).
Exotic pairs add a unique dimension to portfolio diversification. They help hedge against sudden moves in major currencies, which tends to occur around economic releases or important news updates.
Exotic forex pairs do not have a very high correlation with global macroeconomic events or even with traditional instruments like equities and bonds. This allows traders to develop a more refined trading strategy.
Currencies of emerging markets provide higher interest rates for holding positions overnight. However, traders will need to consider the overnight charges when trading these.
When creating a trading plan that includes exotic currency pairs, it’s best to keep some margin of error to account for slippage.
Here is a list of the most traded exotic pairs. This means they have the highest volume and lowest slippage among exotic pairs.
Did you know?
Exotic pairs can be formed by two exotic currencies as well. The most common are:
The valuation of exotic currencies is different from that of major ones. While currencies like USD and GBP tend to move with economic data releases, such as GDP reports or interest rate hikes, the value of the exotic currency is mostly affected by the political landscape of the country. A stable political system that is trusted by the citizens pushes currency prices higher, which political unrest can make the currency unstable, with a downward pressure.
For instance, the Turkish lira plummeted after a massive earthquake struck the country in the second week of February 2023. However, the TRY/USD forex pair had already lost around 30% over the past year due to a steep decline in President Recep Tayyip Erdoğan’s popularity and government elections slated for June 2023.
Due to fewer market forces impacting exotic forex pairs, their trading strategies can be quite simple and straightforward. Here are a few of them.
This requires observing the price movements over an extended period and riding the trend. Traders open long positions during an uptrend and short positions during a downtrend. Quantitative data helps identify an impending reversal, signalling to close the position. Stop loss and trailing stop loss are effective risk management techniques when trading exotic forex pairs. Additionally, setting the take profit limit helps traders book profits before the trend reverses.
When the price of a currency pair fluctuates within a range, traders take advantage of peaks and troughs. They identify entry points using candlestick patterns such as wedges and triangles. Range trading helps traders take positions when the market moving sideways, with order limits at the support and resistance levels.
Breakout traders often combine technical and fundamental analysis techniques to identify the potential and signals of a foreign exchange pair being ready to break out of a range. It is a proactive strategy rather than a reactive one. A directional price move, breaching support, or resistance level marks the entry point for traders. Technical indicators such as pennants, and wedges, combined with an increase in trading volume and volatility are strong breakout signals.
Forex trading with exotic currencies is possible either by directly trading the currencies or via derivatives like CFDs. Direct trading requires higher upfront capital, while CFD trading is possible with lower capital, as leverage reduces the entry barrier. However, traders must be cautious as leverage can amplify both the potential profits as well as losses.
Trading exotic currencies demands deeper market study to understand the movement patterns of the currencies. Additionally, different exotics may move differently.
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