Business Daily.
A+ R A-

Should You Trade Exotic Currencies?

When it comes to accessing the foreign exchange and formulating a viable forex trading plan, there’s a tendency to focus on so-called “major” and “minor” currency pairs.

To provide some context, a study conducted in 2016 by the Bank for International Settlements found that the major USD/EUR pairing accounted for a staggering 23.1% of all daily forex transactions.

Conversely, only one ‘exotic’ pairing (the USD/RUB) had a daily trading volume share in excess of 1% (1.1%), with this highlighting a stark difference between these seemingly similar asset types.

But what are exotic currencies, and should you trade them as a beginner? Let’s find out!

What Are Exotic Currency Pairings?

Major currency pairs pit the fiat currencies of seven developed economies against the dominant US dollar (which is on one side of 88% of all forex trades).

To this end, the seven major pairs comprise 68% of the forex market’s trading volume, well ahead of minor currency pairings and exotic alternatives.

In fact, exotic currency pairs are a distant third when it comes to popularity and trading volume, with these assets combining one of the eight major currencies (predominantly the USD) with a currency from a developing or emerging economy.

You’ll also find some pairings that pit one exotic currency against another, with relatively popular examples including NOK/TRY and TRY/RUB.

Interestingly, exotic currencies make up the vast majority of the 170 such assets available through the foreign exchange, so the question that remains is why are such pairings relatively unpopular in the forex marketplace?

Understanding the Nature of Exotic Currency Pairs

The primary answer lies in the inherently volatile nature of exotic currencies. Because such entities aren’t backed by fundamentals such as large economies or optimal trade volumes, they’re more susceptible to sentiment and volatile price movements.

In fact, the emerging economies that underpin exotic currencies are often plagued by geopolitical uncertainty, creating stunted economic growth and considerably less investment from overseas over time.

At the same time, exotic currency pairs are far less liquid than major or minor assets, making them harder to buy and sell in real-time and increasingly the prospect of incurring losses.

This alters the risk-reward balance when compared with major and minor pairings, potentially deterring inexperienced traders and investors who have previously achieved success with more liquid pairings.

Of course, there’s pros and cons associated with this type of proposition. For example, while the increased volatility of pairings may increase the risk and potential scope of loss (especially when accessing higher levels of leverage), this can also optimise returns and unlock trading opportunities that may not exist in more established pairs.

You should also note that emerging market currencies typically feature noticeably higher rates of interest, which may make them more attractive for carry trades (which involve borrowing capital at a low-interest rate and investing in an asset that provides a significantly higher rate of return).

Overall, exotic currency pairs offer a unique and compelling opportunity to diversify your trades, which is ideal if you’ve begun to achieve success with your existing strategy but want to scale your portfolio in line with increased profitability and greater market experience.

So, Are Exotic or Emerging Market Currencies for You?

Ultimately, the composition of your forex portfolio and the precise range of currency pairings that you trade is completely unique and personal to you.

However, we can see that exotic currency pairings are considerably more volatile than major or minor alternatives. Because of this, they should generally be used to augment or diversify an existing portfolio, unlocking new opportunities and potentially increased profits while retaining the bulk of your capital in more liquid assets.

We should also note that most exotic and emerging market currencies are quite sensitive to changes in the US base rate and economic performance, with the Turkish lira and Russian ruble offering relevant examples. During times of economic tumult, for example, traders will often favour major and safe-haven assets like the USD and JPY over more exotic alternatives.

So, you may want to target exotic currencies during periods of growth and expansion, but it’s important to follow market and macroeconomic trends before executing any forex strategy.

Finally, you’ll need to understand which exotic currency assets are the most popular in the contemporary marketplace.

For some of the reasons referenced above, pairings involving the USD tend to be the most popular. In particular, the USD/TRY and USD/RUB boast the highest daily trading volumes, thanks to the respective strengths of the Turkish and Russian economies and the trade relationships that exist between the relevant nations.

So, incorporating these pairings into your portfolio is to be recommended when dabbling in exotic currencies for the first time, as they strike an optimal balance between risk and reward and remain relatively liquid when compared to other emerging market assets of this type.

Business Daily Media