Is it worth trading exotic currencies: the pros and cons

Hello fellow traders!

Most of the attention in the Forex market is paid to major currencies. This happens for simple and understandable reasons: high liquidity, relatively low volatility, protection from local crisis phenomena. However, each of us, to one degree or another, tracks at least one exotic currency in which the money of our own country is denominated.

In today’s article, we will analyze the pros and cons of trading exotic instruments.

The name “exotic pairs” includes an extensive definition of less common low-liquid national currencies paired with the dollar or euro. They can belong to European states (Norway, Denmark, etc.) or large Asian countries (Hong Kong dollar, rupee, Korean won), but mostly these are currencies of developing countries with a low level of contribution to the world economy.

A simpler definition of exotic pairs is any pair that goes beyond 28 combinations of 8 major currencies:

Why do traders trade exotic currencies?

The most common reason for trading “exotics” is home currencies. Each of us knows the “diseases” of the currency of our own state, hedges inflation risks, protects income.

The largest influx of traders into exotic currencies is observed when a country is experiencing a local economic crisis. Problems do not disappear overnight, volatility and short-term weakening against the dollar and euro give speculators the opportunity to “currency hype”.

For constant trading on exotics, you can use the following strategies:

Carry trade on the local currency exchange;

If a trader has access to loans in dollars or euros at a low interest rate, he can convert them into local currency by placing a deposit on the exchange and buying national government bonds. These are liquid securities, they are accepted by the broker against margin collateral, which allows the trader not to spend money on opening a long position in the dollar futures.

A currency derivative “protects” credit funds from depreciation in the event of an unexpected fall in the value of the national currency. Interest on a foreign currency loan may be several times less than the rate of the national Central Bank – this difference will be a guaranteed and almost risk-free income for a trader.

Trading in the currency corridor or oriented mode;

Most of the “exotics” have a so-called special exchange rate regime. The National Central Bank is obliged to maintain a tight peg to one currency or a basket of major currencies (majors). The IMF admits that the local regulator can keep the rate not in a specific linear relationship, but in a certain corridor, the parameters of which are public information.

The strategy of traders who trade “corridor exotics” is quite simple – buying the national currency at the lower border or selling at the upper one in order to “pick up” the rebound. The corridor can be recalculated and enlarged, therefore a short-term strategy is used.

Focused mode means that the Central Bank is obliged to provide a one-to-one peg of the national currency rate with the euro, the US dollar or other “anchor” major currencies. This is not feasible in day-to-day trading on the exchange, which gives traders the opportunity to catch deviations from the currency constant from the top and bottom.

The Emirates Dirham (AEDUSD) is an excellent example of the stability of the exotic exchange rate paired with the US dollar, where candlestick tails provide daily profit opportunities.

A similar example for the euro is the Danish krone, the local Central Bank strives to finish trading at a rate of 1: 1 with the euro every day, but deviations are still present on the chart.

Raw guides.

Developing countries often have a structure of exports with a sharply dominant share of agricultural products or minerals, the rise in prices of which can lead to strong trends in the national currency. In more detail, the influence of raw materials on the course, nuances and trading strategies are described in a separate article on our website.

If a trader is able to predict crop yields, has access to raw material consumption forecast analytics and knows the local news of the country, then he will be able to create medium-term strategies for certain exotic currencies.

Why not trade exotic currency pairs?

Any traded instrument – currency, stock, bonds or commodity – has features, knowledge of which allows a trader to study and create a set of certain patterns that guarantee a high probability of profitable trades:

Learning about exotic pairs will take a lot of time to the detriment of the rest of the trade;

Trading in major currencies gives 8 pairs and 28 different combinations – this is enough to implement the principle of a multi-currency strategy and save trading from unpredictable movements of exotic pairs. They may arise as a result of the internal policy of the state or the specifics of the current local economic situation.

Exotic pairs change correlations unpredictably;

An example is the two-fold fall of the ruble in 2014, a sharp decline in the Turkish lira in 2016. In the same year, the rupee depreciated due to an unexpected monetary reform. As for the CIS currencies, one can recall the strong strengthening of the hryvnia in 2019, the sharp collapse of the Kazakh tenge in the summer of 2015.

High risks – small leverage;

Traders are often attracted by the high volatility of exotic pairs. In a day, the currency can bring in three to five times more profit than the “fast” pairs with the yen. But high volatility increases losses due to stop sizes, and brokers often limit leverage for such instruments.

If there is no such practice of restrictions, then the trader should be prepared for a high level of stop-outs, the risk of non-market quotes, gaps, slippages and other technical overlaps. The broker is not interested in “exotics”, hence all the problems with trading support.

“Long Calendar”.

Daily preparation for the trading session provides for the compulsory study of the calendar of economic news. Exotic currencies will increase the time of this process, as a trader will have to track an array of information for each country in order to be prepared for unexpected movements within the day or to be aware of changes in monetary policy.

Conclusion

Trading in exotic currencies is quite specific and requires additional time to study the features of each of the selected currency pairs. It will be difficult for a trader to trade exotics using technical analysis, some of them have a limited trading time within the day, volatility and gaps introduce a high error in the values of indicators that generate many false signals.

On the other hand, the specificity of exotic currencies, upon careful study of the history and fundamental features, will give the trader a set of patterns that are profitable in the long term.

This phenomenon can often be observed in “home currencies” – for example, speculators who trade the ruble on Forex make money on tax periods, surges of volatility while working on the Bank of Russia market, etc.

Exotics allow you to occupy your own niche, working out the nuances that market makers and large players who speculate on major currency pairs do not pay attention to.

Take care, Michael

Forextraderportal.com

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