Let's Start With Definition
Exotic pairs are the instruments that include the US dollar or the euro on the one hand and on the other - the national currency from a developing country that makes only a small contribution to the global economy. This mainly includes:
- Major Asian countries such as Korea, India, Hong Kong
- Some European countries such as Norway or Denmark
In addition to USD and EUR, exotic pairs never include currency from countries with a large contribution to the economy. These currencies form majors and cross-currencies.
As a rule, exotic pairs are characterized by a low level of liquidity and high volatility, compared to other instruments. In addition, they are affected by local crisis phenomena. For these reasons, exotic pairs are not very popular among traders. However, there are still those who speculate on them.
Why Trade Exotics
It’s simple. Due to high volatility, exotic pairs bring huge profits.
If a trader decides to trade exotics, this almost always means that the instrument includes the currency of the trader’s home country and he (or she) wants to use the “insider information” that comes to him “first hand” as a resident. Most people stay up to date with the latest news in their region and can use this data in a timely manner for fundamental analysis.
In addition, some traders speculate on random exotic pairs, taking advantage of the current economic crisis in a particular country. At such moments, the local currency begins to sharply lose in value. Traders have the opportunity to earn on this collapse. However, it is important to constantly monitor the latest news in the country. As soon as the local Central Bank takes urgent measures to maintain the state currency, the market can reverse sharply, turning a couple of thousand of profiting pips in a dummy or even a loss.
There are also strategies for constant trading on exotic pairs. An example is trading in an oriented corridor. Some countries, such as the UAE or Denmark, are required to peg the value of the local currency to major currencies such as the US dollar or euro. Since it is extremely difficult to maintain such equalization on Forex, traders have an opportunity to speculate on deviations. On charts, such deviations form very long tails in the daily candles.
Reasons to Avoid Exotics
Groups of currency pairs and each instrument individually have certain characteristics that need to be studied before making your choice in one’s favor. Exotics have a number of characteristics that can become a reason for abandoning them, especially for novice traders.
- A long learning process. Most trading strategies, indicators and Expert Advisors are configured to work with majors and cross-courses due to their universality. To trade on an exotics, you will have to delve into the nuances of trading directly with each pair separately. As well as study the economic and political aspects of each individual country. This one will take you much longer than other trading instruments.
- Low liquidity and high volatility. In simple words, the price will sharply change direction, jumping and forming gaps, which greatly complicates the trading process. In addition, low liquidity increases the number of possible slippages.
- Violation of correlation. Experienced traders that use more than one currency pair know how important it is to monitor the correlation of currency pairs. Exotic pairs often change correlation, and quite randomly.
- Complex fundamental analysis. For major currency pairs, you can use a simple economic calendar to track major global news. For most exotics, you will have to carefully monitor the array of news for a particular country, which makes the analysis more complicated and time-consuming.
- High trading costs. As a rule, exotics have the highest spread. If you are an intraday trader, then the trading cost might be colossal.
- Wide Stop Losses. Due to the extremely high volatility, you will have to set Stop Loss beyond normal to give the market a little space. Thus, the potential risks of exotic pairs are much higher than in majors.
To Summarize
High profits are always associated with great risks. Trading exotic pairs, in the long run, can bring you big money. However, if you are a novice trader, remember that it will take you much more time to study this trade. In addition, the usual rules are not applicable here. Technical analysis gives way to fundamentals. You will have to deal with high spreads, gaps, slippage, and a lot of false signals.
If you still want to focus on exotics, you’d better postpone them for later. First, gain experience in trading on majors and cross-courses. Once you understand how the market works, you can switch to exotic pairs.