What is an ‘exotic’ forex pair?
Currency pairs in the foreign exchange market are typically divided into three types: major, minor and exotic. Major currency pairs are those most frequently traded and the most liquid. Unsurprisingly, they all include the US dollar on one side.
It is generally considered that EUR/USD, USD/JPY, GBP/USD and USD/CHF make up the ‘big four’ pairs, followed by the so-called commodity currencies of AUD/USD, USD/CAD and NZD/USD.
Minor pairs (also sometimes called cross currency pairs) don’t feature the US dollar and include the likes of EUR/GBP, GBP/JPY and EUR/AUD.
Exotic pairs usually consist of a major currency alongside a thinly traded currency or an emerging-market economy currency. Examples include USD/TRY, USD/MXN or EUR/HUF.
A benefit to trading exotic pairs is that they may offer higher potential returns due to wide price fluctuations. However, this means they are riskier to trade.
Exotic pairs make up a smaller share of the total forex market. They are generally illiquid, lacking market depth and featuring low trading volumes and wider spreads.
Anyone considering trading exotic pairs should therefore be a seasoned and knowledgeable trader with some solid and positive market experience under their belt.
Exotic currencies are often those of developing countries and can therefore be subject to more price volatility and bigger price fluctuations.
Major currencies are attached to strong and stable economies such as the US dollar and euro and tend to be moved by interest rate differentials and economic data. Exotic currencies, however, are often heavily influenced by political and economic instability. Such events can cause an exotic currency to depreciate rapidly.
Take the currency crisis in Venezuela, where annual inflation now (January 2019) stands at 224,900%, according to Bloomberg’s Cafe Con Leche Index, and where US dollars were selling at 638 bolívars at the beginning of January, compared to about 213 bolívars at the beginning of December 2018.
Thin liquidity can also cause drastic price moves in exotic pairs because the relative lack of traders means there is less diversity of opinion. So when a price move happens the consensus quickly shifts to cause an extreme move.
Exotics require due diligence
Overall, exotic forex pairs are not for the new or inexperienced trader. Trading in exotics takes some advanced trading skills and a wealth of market knowledge. Only if you’re ready to take on the market risk and volatility involved should you include exotic pairs in your trading plan.
Published: 18 January 2019
You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.