These pairs are the least traded on the currency exchange. There are different reasons for their relative obscurity. The instruments are seen as the riskiest, but why? Should you stick to Forex Major pairs or diversify your instruments with Exotics? This article will answer the most typical questions.
Forex is inherently risky. Like any other form of investment, it is susceptible to external factors. The currency market is the largest in the world, and it is affected by a wide range of drivers. Currencies gain or lose value based on economic and political stimuli: changes in interest rates, trade balances, oil prices, etc. Each currency is linked to the health of the economy it represents.
Exotic Forex pairs are a special category of instruments. They are seen as the least liquid and the most volatile. These combinations can be worth trading, but only for certain categories of participants. Let’s start with the basics.
Definition of Exotic Pairs
So, how many Forex pairs are there in general? Dozens and the available range depends on your broker. Generally, you are offered three categories of currency pairs. Majors are the most popular, as they offer the highest market liquidity and stability. Minors come second, while Exotics constitute the rarest choice. To understand what they are, it is necessary to touch upon the strongest contenders.
Top Forex pairs represent the strongest economies on the planet. The US dollar is the ultimate leader, as it is the global reserve currency. Other popular options include the Euro, British pound, Japanese yen, Swiss franc, Australian dollar, Canadian Dollar, and New Zealand dollar. These are valued against the USD, thus forming Major pair. They are estimated to account for over 80% of all trades.
Minors also represent powerful national economies. So, what is different about them? It is simple: they do not include the USD. These strong currencies are valued against one another – for instance, EUR/GBP. The combinations are also referred to as ‘crosses.’ Aside from the pound sterling and Euro, popular choices include the Japanese yen. While the currency of the EU is regarded as the second most powerful globally, the yen prevails in Asia.
Usually, this trio ( EUR, JPY, and GBP) attracts a significant number of trades, coming second after the US dollar. Now, what about Exotics? The most basic definition is any currency pair that is neither Major nor Minor.
However, this does not mean all Exotics are low-value choices. For instance, the Saudi Arabian riyal and the Kuwaiti dinar are both valued highly. The key motivation for including them in the category is low popularity among traders. Thus, while you hear that Exotics represent weaker economies, this is a superficial view. So, is it a good idea to trade them?
Specifics of Trading Exotic Pairs
In Forex trading, the term volatility refers to the range of ups and downs a currency may go through. The more volatile it is – the bigger the swings. As traders capitalize on changes, they may also profit from Exotics. The key condition is being smart about it. Read more about Five Stupid Forex Trading Mistakes
Highly volatile currencies are not for everyone. Potential profits rise along with potential risks. An abrupt movement up or down may cause you sizeable gains or serious losses, depending on your foresight and risk management techniques.
Most Preferable Exotic Pairs for Beginners
For newbies, Exotics are definitely not the best Forex pairs to trade. They should not be tackled until you gain experience with popular instruments. To balance potential profits and losses, begin with the safest choices within the category. These are five combinations:
- JPY/NOK – the Japanese yen against the Norwegian krone;
- GBP/ZAR – the British pound against the South African rand;
- AUD/MXN – the Australian dollar against the Mexican peso;
- EUR/TRY – the Euro against the Turkish lira;
- USD/THB – the US dollar against the Thai baht.
Controversy of Predictability
These pairs are commonly associated with serious and frequent disruptions that make forecasts unreliable. However, experts will tell you that Exotics may also be fairly predictable, and lucrative opportunities become available if you are watchful. Some traders even consider them to be more foreseeable than Majors and Minors.
The most vivid example is trading Exotics valued against the USD or another robust currency. If you spend time comparing charts for different combinations, you will notice that the American currency dictates the movement. As it is the most prevalent currency in the world, it overpowers everything else. Thus, two different exotic pairs may exhibit similar dynamics. Also, read more about 5 Forex Jobs: Trade Careers List
Hence, if you are knowledgeable about the US economy and can foresee its development, you may benefit from trading several Exotics at once. Generally, the American economic system is regarded as the most predictable, as the media offer an abundance of information to draw conclusions from. This makes USD the most popular choice as quote/base currency – movements of the pound sterling are harder to predict.
The second obvious advantage is the fact that Exotics are ‘technically obedient’. This means that when you think they are heading for a breakout, it usually occurs. Meanwhile, Majors and Minors may reverse due to a wide range of specific factors.
Risks in Trading Exotics
Generally, newbies are strongly advised against trading exotic pairs. Their dynamics are more volatile and difficult to predict. Learn the fundamentals of FX strategies and risk management before delving into them.
While Exotics are so reliant on the US dollar, it is still vital to understand the relationship between the two economies. As exotic choices are less popular, reliable and up-to-date data on respective economies may be more difficult to find. Still, you need to understand key drivers behind any changes in value.
So, who is most likely to choose Exotics? Residents of countries where these currencies circulate. It is logical that locals have easier access to relevant information, and they understand how their systems work. For instance, residents of South Africa are more likely to have extensive knowledge of the South African rand. For Westerners, this currency may be obscure.
Low Liquidity: What It Means
The more liquid a pair – the easier it is for buyers and sellers to connect. Basically, liquidity describes the volume of money circulating between a certain currency pair. If Exotics lack liquidity, you may face difficulties trying to execute trades at favorable price levels. The system may be unable to find a match.
For Majors and Minors, this is not an issue. The global exchange sees massive amounts of these currencies bought and sold daily. All these peculiarities may limit opportunities for exotic trade through your broker.
Check if exotic trading is accessible in general, and what restrictions apply. Some companies limit their offerings to Majors and Minors. Others may charge a higher commission for exotic trades. These bring higher risk not just for clients, but for providers as well. These services themselves are also risky.
This means that higher charges are justified. Any brokerage is focused on its bottom line. In order to make up for losses on risky activities, companies have to make the service more expensive.
Some providers motivate their clients to trade bigger volumes, as the pip value is low. In other cases, you may be encouraged to use the swing trading style. This means you keep positions open for longer.
Another possible recommendation is to carry trade. This method allows you to profit from differences between interest rates. Essentially, you borrow currency with low-interest rates to invest in an economy where interest is higher. Here are a few other important takeaways:
- Spreads for Exotics are usually wider;
- Risk is relatively significant;
- Fees are higher;
- More capital may be required;
- Following the news may be challenging;
- Lack of knowledge is detrimental.
The problem with media information is due to the language barrier. After all, you may be interested in trading the Thai baht, but are you willing to master the local language? You can still resort to second-hand sources, which raises the question of translation quality. If financial terms are poorly translated, you risk drawing the wrong conclusions and opening the wrong trades.
Some Exotics are linked to notoriously unstable economies. Currencies of countries with political turmoil may show erratic ups and downs. These are also observed in areas of armed conflict. Big fluctuations can bring massive profits, but only if they are anticipated. Therefore, Exotics are not for the faint-hearted.
Most Exotics pairs include the currency of a developing nation valued against a strong currency. Thus, the most popular Forex pairs are valued against the US dollar. While some brokerage firms may allow you to trade Exotics valued against Exotics, this is the rarest offer today.
After all, as these currencies are often extremely volatile, you need at least one stable anchor for decisions. Hence, trading Exotics against the American dollar has important advantages.
Despite the risks associated with exotic trading, it is worth trying it at least once in your career. Steer clear of these pairs while you are a newbie, though. Your primary goal should be to master positions with Majors and Minors. Here is why.
Exotics As Complicated Instruments
Exotic trading may sound exciting, as price swings may be broad. However, these instruments require thoughtful strategies and knowledge of the connected economies. Major and Minor pairs offer the safest learning opportunities, so stick to these for a while. Learn how to read Forex pairs in general.
As Majors and Minors represent the biggest financial systems, their movements are easier to predict. After all, news about the health of the UK economy is much more accessible than reports on the dynamics of the Turkish lira. Especially if you do not speak the respective language. These pairs are also safer for your broker, which means you will be offered:
- tighter spreads,
- lower margin requirements, and
- higher leverage.
Trading is not gambling, but it is a game of probability. Market changes are predictable to a certain extent, and force majeure is always possible. As Exotics are susceptible to abrupt changes, may traders prefer more stable instruments.
Consistent profit is based on a consistent strategy. Those who want to turn Forex into a source of steady income will focus on things they can foresee. As information concerning Majors is easily accessible, these are the best currency pairs to trade.
Conclusion: Instruments for Pros
Generally, success on the FX market relies on your ability to predict price movement. This means that traders are free to choose any pairs as long as their knowledge is sufficient. Suppose you are a trader based in Thailand. The USD/THB may be a good choice. The base currency is the most popular in the world, so following its health is easy. Meanwhile, the quote currency represents your native monetary system.
As you speak the local language, you get news from original sources and may foresee currency value changes quickly. However, your counterpart from the UK will be unlikely to trade the pair, as Western media supply very little information about the Thai economy.
The key obstacle is the difficulty of research. Although Exotics are often overpowered by the currencies they are paired with, this is not universal. Generally, information on any exotic currency is harder to find, especially in English.
Rookies are advised to stick to the most predictable currency pairs. These are linked to economies they know well and can easily learn about. While Exotics are relatively obscure, they bring profits to special categories of traders. Avoid these instruments unless you are experienced and knowledgeable. Majors and Minors are the most popular for a reason. They are more liquid, more predictable, and offer more favorable trading conditions.
The bottom line is: leave them to professionals. Trading Exotics may sound adventurous, but it is a reckless choice for beginners. Unless you are trading your national currency against a Major, stay away. Stick to safer choices, develop your skills, and make your profit consistent. When you feel confident trading popular currency pairs, Exotics can become an option.