Today’s Forex Guide

Exotic Currency Pairs Trading – Good or Bad?


Apr.17.2015


You obviously would find different people "exotic" depending on where you are from. In Japan, a blond white guy with blue eyes is pretty exotic while American girls (stereotypically) find British or tanned Middle Eastern guys attractive and exotic.

In the forex world, exotic pairs are made up of one major currency paired with the currency of an emerging economy like Brazil, Mexico, or a super exotic country like Iran.

How are Exotics Different from Majors?

Exotics are not considered major currencies because they are not easily traded in a standard brokerage account. Major currencies include the U.S. dollar, Euro, British Pound, Canadian dollar, Australian dollar, New Zealand dollar and Swiss franc.

Here are a few characteristics of exotic currencies:

  • It's not really liquid
  • Lacks market depth comparing to the major and minor currencies
  • Trades at low volumes
  • Spreads and markup fees on exotic currency pairs can be very high
  • Pip value is too low
  • Fundamental market moving events out of exotic countries aren't as widely speculated as majors and minor
  • Often times lacks market cycle, or takes too long to complete a cycle
  •  The pairs move way too much
  • Lack popularity in terms of consistent market activity

List of Most commonly Traded Exotics V.S. US Dollar

 

Currency Pair FX Nickname Symbol
Ms. USA / Mr. Brazil Dollar - Real USD/BRL
Ms. USA / Mr. Mexico Dollar – Peso USD/MXN
Ms. USA / Mr. Hong Kong Dollar – Hong Kong Dollar USD/HGD
Ms. USA / Mr. Singapore Dollar – Singapore Dollar USD/SGD
Ms. USA / Mr. South Africa Dollar - Rand USD/ZAR
Ms. USA / Mr. Thailand Dollar - Baht USD/THB
Ms. USA / Mr. Denmark Dollar - Krone USD/DKK
Ms. USA / Mr. Sweden Dollar – Swedish Krona USD/SEK
Ms. USA / Mr. Norway Dollar – Norwegian Krone USD/NOK

Remember:

Exotic currencies don’t necessarily mean weak or undervalued currencies, but it does indicate limited and “not-so-popular” behavior in the forex party and by forex traders. For example., the Kuwaiti dinar (KWD) and Saudi Arabian riyal (AED) are two high-valued currencies, but they are still considered exotics; not only because most Americans can't point the two countries on the map, but mainly due to limited trading.

Who Trades Exotic Pairs?

First and foremost, people living in "exotic" countries tend to trade their own currency versus a major currency, usually the US dollar.

Other than that, large hedge funds or individuals who follow the politics of an emerging economy closely, would consider trading that country's currency.

How can you make money trading exotics?

Let me be blunt with you: unless you have a great capital and can afford massive risk trading on high leverage, you can't make money on the exotics!

Now, while I mentioned that pip value for exotic currency is pretty low, they can move a fair bit, and sometimes their movements are actually more predictable than majors due to lack of global speculators.

For example, if you look at the USD/ZAR and USD/MXN daily charts snapped on April 17, 2015, you'll notice that they almost look identical because the US dollar has basically taken the lead in the currency pairs' movements.

USD/ZAR Daily April 17, 2015

 

USD/MXN Daily April 17, 2015
Besides directly purchasing an exotic currency, there are several other investment choices to benefit from exotic currency. You can look at more complex offerings like currency futures, currency options and even variants of barrier options on currencies available as OTC products in selected markets. You should keep in mind the complex nature of these products, which further add to complexity of exotic currency trading.

Analyzing Exotic Pairs

When trading or analyzing an exotic currency pair, you will need to look at both the economic calendar for the U.S. Dollar and the calendar for the key economic data releases and events for the relevant exotic currency.

Adjustments in the U.S. Dollar’s value can certainly affect the market determined level of exotic currency pair exchange rates. Furthermore, exotic currency traders need to be aware that the relative value of exotic currencies can also move substantially based on information that is not readily available on most English-language news wires, even though it may be well known within the emerging market country itself.

If you are planning to trade the exotics, that doesn't mean you can kiss the major global events good-bye. On the contrary, you need to keep track of monetary and exchange rate policies that are currently being implemented by the Federal Reserve Bank and the monetary authority responsible for managing the exotic counter currency.

The relative level of benchmark interest rates, such as the Fed Funds Rate set by the Federal Open Market Committee, is also a key factor in the valuation of exotic currency pairs. This is because such rates affect the country’s economic future and they also have an impact on the profitability of the carry trade involving that currency.

Using High Leverage to Trade Exotics

Many forex brokers advertise exotic currency trading and encourage their clients to use a larger trade size in order to combat the low pip value. While that indeed can be an interesting strategy (for the winners) by adding on to your leverage, you are raising your already-high trading fees which is awesome news for the forex broker!

One method to combat these is to stay in your exotic trade for a long time.

These are the things you should keep in mind when entering a long-term exotic trade:

  • Have a clear long-term idea about the exotic country's economy whose currency you are about to trade
  • Make sure you are using disposable money that you won't need immediately
  • Consider carry trading in order to take advantage of high interest rates and rollovers in the current global economy

What is Forex Carry Trade

Carry Trade is a buy-and-hold strategy that is best for yield hunters and trend followers. It's is mostly suitable for long-term traders.

Carry Trading is a strategy in which you sell a certain currency with a relatively low interest rate and use the funds to purchase a different currency yielding a higher interest rate.

The carry trade is a powerful set up where a trader looks to gain not only on the profit or loss of the pair going in the direction of the trend but a strategy that allows you to collect interest payments. You can collect interest daily if you buy the higher yielding currency and sell the lower yielding currency.

So going back to our topic of trading exotic pairs, Carry Trade presents a unique opportunity in the current low interest rate environment that is best found in exotic pairs.

Risks Involved with Exotic Forex Trading

Due to low liquidity and related factors, the following risks are associated with forex exotic currency trading:

  • Lack of Knowledge: Apart from speculation, forex rates are fundamentally determined by demand and supply trends. It gets extremely difficult to track and forecast the developments on such macroeconomic factors for such exotic countries that you don't even know how to speak the language of. This makes it extremely difficult to be on top of the news which leads to lack of awareness and challenges in keeping track of determining factors leads to higher risks.

 

  • Low liquidity:  Most exotic currency transactions occur at banks at pre-determined fixed rates for remittance or similar activities.

 

  • High Transaction Fees: While there are good profitable opportunities in terms of visible price variations over short, mid and long periods of time, high mark-up fees and spreads charged by forex dealers can offset the profit potential.

 

  • Too much volatility: In cases where there is political uncertainty in the currency's country, this leads to high fluctuations, making it difficult even for experienced traders to trade on exotic forex. You never know if the Iranian regime suddenly decides to ignore there recent advances with the international players. If you are thinking of trading the Russian ruble (RUB) for example, the fluctuations can be massive due to many factors including their relationship with Iran and the Ukrainian conflict.

The Bottom Line

Trading the exotics currencies is not for everyone. Short term profit opportunities are tied to high mark-up fees and wide bid-ask spreads. Long term investments require patience, knowledge of economic and geopolitical developments and impacts.

Have you ever traded exotic currencies? How has your experience been? Join the conversation On Facebook and Twitter using #EducationFriday

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