While the currency pairs we hear about most often are the major and minor pairs, there are actually far more exotic currency pairs to trade. In this introduction, we will define the types of currency pairs and cover some of the basics you’ll need to know before you begin trading the ‘exotics’.
Major and Minor Currency Pairs
Firstly, we should define major and minor currency pairs. The following are regarded as major currencies:
- US Dollar (USD)
- Euro (EUR)
- Japanese Yen (JPY)
- British Pound (GBP)
- Swiss Franc (CHF)
- Canadian Dollar (CAD)
- Australian Dollar (AUD)
- New Zealand Dollar (NZD)
Major currency pairs refer to any pair containing one of these currencies and the US Dollar – so while there are eight major currencies, there are only seven major currency pairs.
An important issue in the currency market is liquidity – i.e. the amount of any currency being bought or sold at any time. The most liquid currency pairs tend to have natural supply and demand from exporters and importers in addition to the supply and demand generated by speculators and investors. Since all the countries listed above have substantial trading relationships with the US, constant liquidity is provided by exporters and importers.
Minor currency pairs include any two of the major currencies apart from the USD. Some of these pairs, including GBP/EUR and AUD/JPY represent pairs of countries with active trade relationships, providing significant liquidity. Others, like CHF/JPY and EUR/JPY, have less active natural supply and demand.
Before we move on to exotic currencies it’s important to understand that there are two major forces driving the exchange rate between two currencies; natural supply and demand, and the relationship between those two currencies and other currencies – most notably the USD. If you exchange GBP for EUR, importers, and exporters in both the UK and Europe will be buying and selling both currencies, providing an active market. On the other hand, if you exchange GBP for NZD, there will be fewer importers and exporters active in the market – the quotes will more likely be a combination of the GBPUSD rate and the USDNZD rate. With currencies that are even less liquid, exchanging one currency for another will inevitably involve exchanging the first currency for USD and then exchanging USD for the second currency.
Most forex brokers offer clients forex trading either in the direct currency market or via CFDs (contracts for difference). Either way, the spreads they offer depend on the liquidity of the underlying currency market. Even though you may see a pair quoted as just two currencies, for the trades to take place in the underlying market, at some point an extra leg may have to be executed by a market maker.
What are exotic currencies?
Exotic currencies are any currencies not mentioned already. Some like the Hong Kong Dollar (HKD) and Norwegian Krone (NOK) are actually very liquid, some like the Mexican Peso (MXN) and Thai Baht (THB) are fairly liquid, and others like the Malawian Kwacha (MWK) and Laos Kip (LAK) have very little liquidity.
Exotic pairs are those that include one major currency and one exotic currency. While there are over 150 countries that could be classified as developing nations, trading in exotic currencies is focussed on around 18 currencies. Admiral Markets, a prominent forex broker, for instance, lists 19 exotic pairs including 10 exotic currencies. There are plenty of other exotic currencies, but in most cases, brokers will only offer those that their clients demand.
The following are the most widely traded exotic currencies:
- Norwegian Krone
- Polish Zloty
- Czech Koruna
- Hungarian Forint
- Russian Ruble
- Turkish Lira
- Chinese Yuan Renminbi
- Singaporean Dollar
- Hong Kong Dollar
- South Korean Won
- Thai Baht
- Malay Ringgit
- Indonesian Rupiah
- Indian Rupee
- Mexican Peso
- Brazilian Real
- South African Rand
With any broker, the spreads being offered for a currency pair will reflect the underlying liquidity for that pair. Admiral Markets, offers spreads as low as 0.1 pip for the EURUSD pair (the most liquid in the world) to 5 pips for CADCHF and 10 pips for the USDCNH. For even less liquid currencies, the spreads can be much wider, in some cases reaching 800 pips.
Which Currencies Should You Trade Exotic Currencies Against?
An exotic currency will usually have better liquidity if it is traded against the currency from a major trading partner. The Turkish Lira is therefore usually traded against the Euro, the HKD against the USD or Chinese Renminbi and Mexican Peso against the US Dollar. You would struggle to find a broker offering a Malawian Kwacha/ Swiss Franc pair, but even if you did the spreads would be very wide. In most cases, exotic currencies from countries in or close to Europe are traded against the Euro, and others are traded against the USD.
Pros and Cons of trading Exotic Currencies
The currencies of developing nations are often volatile and prone to trend strongly. Some countries with large current account deficits have structurally weak currencies that have weekend consistently for decades, while others have steadily strengthened over time.
This means there are certainly opportunities for forex traders to profit. The downside is that trading costs can be high and are some currencies are prone to large unexpected moves when government policies are changed without warning.
For the most part, traders need to have a longer-term view when trading exotic currencies than they would with major currencies. The less liquid a currency is, the longer the time horizon should be. Some, like the Norwegian Krone and Singapore Dollar, are very liquid and can be treated like major currencies. However, others, like the South African Rand and Turkish Lira are not suitable for intraday trading, and only suitable for medium-term trading under unique circumstances. In most cases, exotic currencies require time horizons of weeks to months, unless a very unique opportunity presents itself.
Secondly, traders must familiarise themselves with the typical patterns for a particular currency before trading them. Each currency has its own unique personality and there are usually good and bad times of the day and week to trade them.
While trading exotic currencies are less straightforward than trading major and minor pairs, they do offer very profitable opportunities. Every few years there is usually an emerging market currency crisis which results in some currencies moving as much as 20 to 30%. These situations offer forex traders opportunities they will seldom see in major pairs. It is therefore worth learning more about these currencies and adding another tool to your trading arsenal.
This article was originally posted on FX Empire
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