Adding exotic currency pairs to a portfolio is a popular way to get exposed to a wider variety of assets.
These pairs, which include currencies from emerging markets or smaller economies, offer unique opportunities due to their volatility and potential for high returns.
For traders in regions like India and Southeast Asia, exotic pairs can serve as valuable tools for diversification, potentially increasing returns from trading. Octa Broker, a broker with globally recognised licences, explains the basics of exotic pairs and provides tips on how to navigate such a dynamic landscape, where understanding volatility and managing risk is paramount.
Key characteristics of exotic currency pairs
Exotic currency pairs differ from major and cross pairs in several ways, each presenting opportunities as well as challenges for traders.
Higher spreads and lower liquidity
Exotic pairs tend to have wider spreads due to lower trading volumes and reduced liquidity. For instance, the USD/ZAR pair frequently experiences a spread of 100 pips or more, driven by its less active market presence. This wide spread is a broker’s commission for facilitating trades in less liquid markets, and it requires traders to account for this in their profit calculations to avoid unanticipated losses.
Volatility and economic sensitivity
Some exotic pairs exhibit strong trending behaviour, with notable examples like the USD/MXN (U.S. Dollar / Mexican Peso) pair. The USD/MXN pair often responds dynamically to economic factors, particularly commodity prices. As Mexico is a major oil exporter, fluctuations in oil prices can significantly impact the Peso’s value against the dollar.
While exotic currency pairs present exciting opportunities, a deep understanding of market drivers is essential when handling them. Traders must keep track of both local economic conditions and global trends to make informed decisions.
Kar Yong Ang, a financial market analyst at Octa broker, provides a glimpse into factors affecting the USD/MXN pair: ‘Currently, Mexico is experiencing a trade deficit, indicating that its imports exceed exports, which can place downward pressure on the peso and contribute to its weakening. Additionally, market participants are cautious about a potential U.S. recession, leading to an increased demand for the dollar as a safe-haven asset.’ This scenario demonstrates how closely linked economic developments are to the performance of exotic currency pairs, underscoring the importance of staying informed on both local and international factors when trading these pairs.
Strategies for trading exotic currency pairs
Exotic pairs demand a solid grasp of market conditions and robust risk management strategies. For beginners, using a smaller portion of their capital and setting realistic profit goals is essential. For example, they might start by trading small lot sizes in USD/ZAR and adjusting their stop-loss orders to manage risk in the face of potential large price movements. Here’s an example of fundamental and technical analysis a trader can make before opening a deal.
USD/ZAR (U.S. Dollar / South African Rand)
The USD/ZAR pair is influenced by South Africa’s economic conditions, political stability, and the fluctuating value of its key export, gold. With South Africa being a major gold producer, the currency often correlates with gold and platinum prices. When gold prices rise, the Rand typically strengthens, creating opportunities for traders who monitor commodity price movements closely.
Suppose a trader uses the Bollinger Bands indicator to identify buying and take-profit opportunities on USD/ZAR. Entering at 18.00 ZAR and exiting when it hits 18.80 ZAR, the trader secures an 8,000-pip profit, accounting for the 773-pip spread: the 8,000-pip difference excludes the spread. Normally, the spread is less than 100 pips, so the profit is secured. However, even in exceptional cases when the spread is higher, a trader can still seal a successful deal. This scenario highlights both the potential for profit and the importance of factoring in spread and volatility in trading strategies.
Advantages and risks of trading exotic currency pairs
Benefits of diversification
Adding exotic pairs to a portfolio can diversify risk due to the low correlation of these pairs with traditional assets like stocks and bonds, as well as major currency pairs. Since the exotic pairs include a popular currency and the one from a developing country, the determining factors that affect the price significantly differ from those impacting major pairs. This allows for a different set of trading opportunities.
Risks to consider
The high volatility and wide spreads of exotic pairs mean that traders must exercise caution. Without proper risk assessment, trading exotics can lead to significant losses. Monitoring local economic indicators and staying informed about global events are crucial for traders who wish to navigate these challenges successfully.
Exotic currency pairs offer intriguing opportunities for traders looking to explore beyond conventional assets. With their high volatility, unique correlation patterns, and sensitivity to both local and global factors, exotics provide an alternative avenue for diversification. By staying informed and applying sound strategies, traders can leverage the potential of exotic pairs while mitigating the associated risks.