Currency pairs in the FX market are classified into majors, minors, and exotics in order of their popularity among traders. Majors are preferred by most because they offer high volatility, high liquidity, and low spreads. Exotic pairs, which mostly belong to the third world or developing economies, have even higher volatility levels than the majors. However, their liquidity is quite low due to the low volume of market participants. However, there are still some exotics that are worth trading.
Currency pairs – what are they?
In the currency market, currencies are traded in twos, hence forex pairs. Considering the CADUSD pair, the first currency is called a base or transaction currency. Its counterpart is called a quote or counter currency. This is because the pair’s price at any one time quantifies one CAD in terms of US dollars, i.e., how many USD it would take to purchase one CAD.
1. Major pairs
As aforementioned, these are the most popular currencies among forex traders. They take the bulk of the traded volume because of their higher liquidity, which means orders are executed close to or at the quoted market prices, thus reducing slippage costs. Due to the large volume of buyers, sellers, as well as brokers offering them to traders, these brokers will often charge competitive spreads. This attracts traders as they get to keep a bigger share of any profits they make.
Currencies in major pairs represent the biggest economies in the world. As a result, getting fundamental information about their economies is a pretty easy feat, which makes the pairs easily tradable and,, to a degree, predictable. These pairs include EURUSD, NZDUSD, USDJPY, AUDUSD, GBPUSD, USDCAD, and USDCHF.
2. Minor pairs
These come second on the popularity scale among FX traders. Sometimes, they will be referred to as crosses. They have lower liquidity than majors, which means slippage costs will be slightly higher. Their common factor is they do not include the US dollar. Instead, they will contain the currencies of any of the other major global economies. They include EURGBP, NZDJPY, EURJPY, EURAUD, GBPJPY, CHFJPY, and GBPCAD.
3. Exotic pairs
These are the least traded pairs in terms of volume. They involve a coupling of a currency of one of the major global economies and another from a developing economy. It is also not uncommon to see a pairing of currencies of two third-world countries, such as the TRYRUB (Turkish Lira and Russian Ruble).
Traders who dabble in these pairs mostly do so to diversify their portfolios. Due to their high volatility, they offer increased chances for profit from their large price moves. However, this volatility also poses the risk of bigger losses. Further, most third-world countries have high-interest rates, which makes their currencies well suited for carry trades.
Prerequisites to trading exotic pairs
Before you can trade exotic pairs, you need to be well aware of their vital characteristics. For one, these pairs are heavily influenced by the interest rate decisions from the US Fed. Their performance is also heavily dependent on the general risk sentiment of the market. For instance, when the world is in economic turmoil, perhaps during a global crisis, investors generally rush to safe-haven currencies such as the USD and stay away from currencies from emerging markets. Additionally, as aforementioned, these exotics have far less liquidity than majors and minors, and they also have higher volatility than both.
Trading strategies for exotic pairs
1. Scalping
Scalping traders hold positions for very short periods, usually minutes at a time. Such traders rely mainly on technical analysis, as the fundamental analysis doesn’t usually cause established moves in such small timeframes.
2. Day trading
Here, trades are held for longer, going on hours, but day traders never let their positions remain open overnight. Such traders will rely on technical analysis most of the time, but they’ll also be on the lookout for major events on the economic calendar, as well as any geopolitical developments.
3. Swing trading
In this approach, traders keep their positions open for several days or even weeks. Usually, they trade alongside major trends and ride them till a reversal happens. For this reason, they need to utilize both technical and fundamental analysis.
4. Position trading
This is a rather long-term strategy that spans months or years. Position traders will mostly trade on fundamental news, looking to benefit from the trajectory prices follow after such major releases.
Pros and cons of trading exotics
Pros
- They are less affected by other financial markets such as the stock market, which reduces the influence of macroeconomics on their performance.
- They are more volatile than other pairs, hence offering increased profit potential from their price moves.
Cons
- They have low liquidity, hence increased slippage costs.
- Brokers will usually charge higher spreads for them.
- Their high volatility could expose traders to larger losses.
- Third-world governments often change monetary policies on a whim, which could rapidly devalue a currency.
Who should trade exotic pairs?
If you’re a beginner looking to dip your toe into FX trading, exotic pairs may not be a suitable fit for you. The lack of economic information on them, coupled with the high spreads charged by brokers for their trades, makes them quite difficult to trade. What’s more, they are highly volatile, which means one wrong move could easily blow your account.
Therefore, these pairs are better suited for professionals who have the technical know-how to develop working strategies for these pairs.
Conclusion
Exotics are those that belong to emerging economies and are often coupled with a currency from a developed country or that from another third-world country. They are characterized by high spreads, low liquidity, and high volatility. They are also greatly affected by US interest rate decisions and the general risk appetite in the market. Because of their risky and unpredictable nature, these pairs are best suited for professional traders.
