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In the foreign exchange market, currencies are traded in pairs (one currency versus another currency [hence the term ‘currency pairs’]) and categorised into three distinct types: major, minor, and exotic pairs.
Major pairs, like the euro to the US dollar (EUR/USD), always feature the US dollar and another major currency. Minors, also called crosses, feature less popular (liquid) pairings but still consist of two currencies from developed economies, like the euro to the Japanese yen (EUR/JPY).
Exotic forex pairs typically include a major currency, like the US dollar, paired with the currency of a developing or emerging economy, such as the South African rand or the Turkish Lira. They are less frequently traded, producing lower liquidity and higher volatility than in major and minor currency pairs. An example of an exotic pair is the US dollar to the Singapore dollar (USD/SGD).
Exotic pairs are so named because of their distinctive nature in the forex market. The term ‘exotic’ is typically associated with rareness or uniqueness, which seems apt considering that emerging market economies only made up 17.8% of average daily forex trading volumes in 2022 (Bank for International Settlements). For comparison, the EUR/USD major currency pair accounted for a massive 22.7%.
Exotic pairs include currencies from countries with less stable economies with relatively limited global influence. This makes them ‘exotic’ because they aren’t as accessible to the average trader and, therefore, not as frequently encountered.
Exotic forex pairs are known for several distinct characteristics that set them apart from their major and minor counterparts.
High Volatility:
Exotic pairs tend to be highly volatile due to their low trading volumes and illiquidity, often prompting larger price swings than in more liquid pairs. Economic and political uncertainties in emerging market economies further drive volatility and illiquidity.
Wider Spreads:
Due to their lower liquidity, exotic pairs exhibit wider spreads—the difference between a currency pair's buying price (ask) and the selling price (bid). This can increase trading costs and slippage (orders filled at less-than-preferable prices), making them difficult to trade in the short term (trading styles such as scalping and day trading).
More Sensitive to External Events:
In highly liquid markets, unexpected shocks can be more easily absorbed due to more buyers and sellers at each price point. In less liquid exotic currencies, local economic and political events can have an extreme effect on prices.
Before we take a closer look at some exotic currencies, we must first familiarise ourselves with the seven major currency pairs that feature the US dollar. These pairs include the following currencies:
These seven pairs consist of the eight major currencies that dominate the foreign exchange market. They represent some of the world’s largest and most developed economies and account for most of the market’s volume.
Let’s now turn our attention to the more unique exotic currencies. As a general rule, exotic pairs featuring the US dollar are the most frequently traded, followed by the euro, the Japanese yen, the British pound, and the Australian dollar.
Some of the most liquid and well-known exotic currencies are:
Identifying exotic forex pairs to trade is subjective and depends on your preferences and knowledge of specific economies.
As discussed, several factors can drive volatility in exotic pairs. However, some elements may have a more considerable effect on exotic pairs than major pairs.
Economic Stability:
Like all currency pairs, exotic pairs are influenced by economic indicators, like GDP, inflation, and employment data. However, since emerging markets are considered riskier investments, these nations' economic events may produce sizeable price movements as market participants rush to enter or exit the respective currency.
Political Climate:
Likewise, exotic currencies can be particularly sensitive to political events. Developing countries may have a less stable political climate, pursue extreme policies, or face greater geopolitical risks, leading to double-digit gains or losses in an exotic pair.
Commodity Prices:
Many emerging economies are heavily dependent on commodity exports. As such, fluctuations in global commodity prices can impact the value of their currencies. For example, a substantial increase in the price of coffee and sugar may strengthen the Brazilian real.
Global Trade Relationships:
The trade relationship between the country of the exotic currency and the major currency can also influence the pair's value. For instance, changes in US-Mexico trade policies could impact the USD/MXN pair.
Market Sentiment:
Lastly, market sentiment can severely affect exotic pairs. During global economic uncertainty, traders may prefer ‘safe-haven’ currencies, like the US dollar or Swiss franc, causing exotic currencies to decline rapidly.
Trading exotic pairs may seem daunting due to their volatility and complex influences. However, there are several compelling reasons why you shouldn’t dismiss them straight away.
While trading forex inherently carries risks, exotic pairs can be particularly risky. Some of the most notable risks involved include:
Trading exotic pairs requires a different approach than their major and minor counterparts. While much of the mechanics are the same, the added volatility and illiquidity can present opportunities and challenges. Here are three broad strategies that can be used.
Carry Trade:
A carry trade involves borrowing in a currency with low-interest rates and investing in a currency offering high-interest rates. For instance, a trader may borrow the Japanese yen (since Japan favours ultra-low interest rates) and trade it for the South African rand, which currently sits at 7.75% in May 2023. They’d then invest in a rand-denominated asset that yields a similar interest rate, collecting the difference when they repay their yen loan.
Fundamental Analysis:
Fundamental analysis uses economic data, political events, monetary policy, and market sentiment to predict exotic pair trends. As mentioned, exotic currencies often have less available information than major currencies, meaning market inefficiencies exist. This means that if a trader can deeply understand an emerging economy and its currency, they may be able to exploit opportunities not widely known to the market.
Technical Analysis:
Technical analysis involves using indicators, support and resistance levels, trend lines, and so on to identify potential entry and exit points. The added volatility of exotic pairs can make technical analysis easier, as price action is more distinct.
However, wild price swings may invalidate a trader’s technical analysis more easily. As a result, traders may have more success setting a bias using fundamental analysis, then confirming their bias and finding entries using technical analysis.
With the idea of confirming fundamental analysis with technical analysis in mind, let’s look at an example involving the USD/MXN.
(Trading View – Daily Timeframe)
Donald Trump, leading up to his 2016 presidency, heavily criticised the North American Free Trade Agreement (NAFTA) between the United States, Mexico, and Canada, stating his intention to renegotiate or withdraw from the deal. After his inauguration on the 20th of January 2017, expectations of a NAFTA renegotiation were confirmed.
Concerns around disruption in trade and economic growth drove the US dollar lower against the Mexican Peso, falling from 22.0375 to a low of 17.5752 in July 2017. Traders expecting decreased demand in the dollar could’ve anticipated this drop and confirmed a short entry after support (blue line) was traded through and a subsequent retest of the level was realised.
You now have a solid overview of exotic pairs, their driving factors, and their pros/cons. While you might feel ready to start trading exotic forex pairs, it’s important to remember several key points before diving in:
With FP Markets, a leading forex and CFDs brokerage, you can trade more than 70 currency pairs, including the newly added emerging currencies: Mexican Peso (MXN), Brazilian Real (BRL) and South African Rand (ZAR) against the US dollar.
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