According to the United Nations, there are at least 154 recognized currencies from 221 nations. Mathematically speaking, we could derive 11781 pairs from this range alone, but of course, the reality is very different.
If we look purely at the retail spot forex market, traders are exposed to perhaps around 120 pair combinations from this bunch on average. This collection is still massive, which exemplifies the diversity and abundance of opportunities in the markets.
Life is made easier for traders as pairs are divided into major, minor/cross, and exotic, each of which is more followed and speculated on than others.
Major currencies – AUD (Australian dollar), CAD (Canadian dollar), CHF (Swiss franc), EUR (euro), GBP (British pound), JPY (Japanese Yen), and NZD (New Zealand dollar) – are coupled with the US dollar.
These markets are evidently the most traded because of the prominence of their respective economies on a global scale. The majority of forex transactions occur within this group daily.
These pairs are identified by highly liquid movements, relative stability, and low transaction costs. When we come to minor or cross pairs, we look at the fusion of all the previously listed seven without the US dollar.
These instruments are also prominent and similarly characterized by solid movements, reasonable predictability, and cheap spreads. Lastly, we have exotic pairs, which are sometimes misunderstood and generally avoided by most for a few reasons.
Despite being less significant, exotics are interesting to observe and should form part of the portfolio primarily for long-term traders.
What are exotic pairs?
Exotic pairs are currency markets derived from so-called developing countries like South Africa (rand/ZAR), Turkey (lira/TRY), etc., against the established major currencies, i.e., USD/TRY, EUR/ZAR, and so on.
It is a slight misnomer that all exotics consist of currencies used by emerging nations. Nations like China, Russia, and Mexico have highly developed economies, and one of the highest nominal GDP (Gross Domestic Product) figures worldwide.
Furthermore, the complexity of predicting price movements for exotics isn’t any harder than with other instruments. Looking purely at all forex transactions globally, they still generally make up the least portion since they are thinly traded.
Consequently, exotic pairs are known for being illiquid, somewhat erratic, and incurring higher spreads and swaps to compensate for the lack of trading volume. As a result, the consensus within the trading community is traders staying away from such markets.
However, exotics provide a different avenue from the more frequently speculated instruments and tend to be more volatile than their counterparts. These attributes are beneficial, especially for swing and position traders who can offset the expensive spreads with larger profit targets.
List of most common forex exotic pairs
The list below contains the most common currencies in exotic pairs traders would come across in their journey with numerous brokers.
- CNH or CNY (Chinese yuan)
- CZK (Czech koruna)
- DKK (Danish krone)
- HKD (Hong Kong dollar)
- HUF (Hungarian forint)
- MXN (Mexican peso)
- NOK (Norwegian krone)
- PLN (Polish zloty)
- SEK (Swedish krona)
- SGD (Singaporean dollar)
- TRY (Turkish lira)
- ZAR (South African rand)
We should bear in mind this list isn’t exhaustive as other more exclusive brokerages offer other even rarer exotic instruments.
Characteristics of exotic pairs in forex
Aside from being less popular and expensive to trade than their more prevalent counterparts, exotic pairs are principally more volatile. In other words, they tend to move a greater distance over the same span as other markets like EUR/USD.
Let’s compare the average daily volatility of the euro against the USD/CNH, the latter of which is one of the most popular for exotics. At the time of writing, the average pip range for EUR/USD is 63 pips, while USD/CNH is 210 pips.
On the extreme side, markets like USD/ZAR can easily move 2000 pips in a day, with regular daily price changes being 2% or more. While this presents the potential for huge profits, the stop losses often need to be larger to stomach the higher and sometimes erratic volatility, along with the bigger spreads.
Another unique factor of exotic pairs is the high interest rates their respective countries have compared to the majors and minors, a critical feature of the carry trade. The carry trade is a unique strategy practiced by position traders who exploit positive interest rate differentials between two currencies.
By buying a currency with a higher interest rate and selling one with a lower interest rate, the trader pockets through recurring swaps on a daily basis. As position traders aim to hold their trades for very long, typically months to even years, these swaps can accumulate to a reasonably sizable amount over time.
Who should trade exotic pairs in forex?
Generally speaking, newer traders and those with a much shorter holding time are better off without trading such markets. Fortunately, this group of speculators can find the same opportunities in the majors and minors with more stability and much cheaper spreads.
Something else worth noting is the vast majority of forex markets are highly correlated. Thus, taking a short position on, for instance, GBP/USD is effectively the same as taking a long position on USD/MXN in many cases.
These relationships are especially evident in the short term, further adding to why those attempting to profit immediately should stay away from exotics. Swing and position traders have the advantage for several reasons, one of which is not being affected by any teeny-weeny correlations when having multiple positions in closely related markets.
Secondly, this mass of investors is also not affected by larger spreads because their profits overall should more than compensate.
Although coverage on exotic pairs is not something we’d see on Bloomberg TV, this subset of forex is quite intriguing. Long-term traders can particularly benefit from these markets to broaden their horizons of opportunities and participate in potential carry trades.
Regardless of the style and strategy, it’s always crucial for speculators to note the costly spreads, above-average volatility, and sometimes unstable nature of exotics to trade accordingly.