What are exotic currency pairs in Forex

If you have been spending time learning about the Forex market, there is a good chance that you have heard traders referring to ‘Major’ and ‘Minor’ currency pairs, as explained by otet. However, eventually, there will be another category of currency pairs that traders discuss, which is mostly unknown and tends to intimidate; this category is called Exotic Currency Pairs.

Exotic currency pairs typically incur larger price fluctuations, higher transaction fees, and tend to have legitimate world issues or political ramifications attached to them. For some traders, this is viewed as an opportunity, whereas for others exotic currency pairs are viewed as a risk that should be managed cautiously.

This guide will take all of the information about exotic currency pairs and break it down into a simple and easy-to-understand manner. There will not be a lot of heavy terminology or complexity; it will simply be a breakdown of what the exotic currency pair is, how it functions, and for whom the exotic currency pair is.

Definition of Exotic Currency Pairs

Exotic currency pairs refer to a combination of one major global currency (often a USD) and a currency from a smaller or developing economy.

They may also be combined with European and Japanese currencies like the Euro and Yen but generally include currencies from countries with emerging economies, i.e., those with less-developed and less-integrated financial systems on a global scale.

An exotic currency pair is defined not so much by its rarity in terms of being an outlier in the forex market, but rather by its lower liquidity, lower trading volumes, and economic circumstances of the countries that issue the currency. Exotic Currency Pairs in Forex are often misunderstood because they behave very differently from major and minor currency pairs.

When discussing exotic pairs, you will commonly see them referred to as “Exotic Currency Pairs.” This is simply a term that we use to categorize these pairs differently than our major pairs (e.g., EUR/USD) or our minor pairs (e.g., EUR/GBP).

Exotic currency pairs have lower trade activity as compared to major and minor currency pairs. As a result, exotic currency pairs have a higher probability of price movement than other currency pairs and they tend to have wider spreads. These factors contribute to the uniqueness and challenges associated with trading exotic currency pairs.

If you are new to Forex, understanding What is a currency pair in Forex? will make it easier to grasp how exotic pairs function.

Read More: What is a currency pair in Forex?

How Exotic Currency Pairs Are Formed

Every Forex pair has two sides: a base currency & quote currency. Exotic currency pairs are also structured similarly, however one side of the exotic pair typically represents the currency of an emerging economy.

For example, USD paired with any Latin American, Southeast Asian, Eastern European or African currency is a well-known example. In this case, the major currency provides the majority influence globally, while the exotic side reflects more localised economic conditions.

Even with lower trading volumes, exotic pairs still exist because international trade capital and investment flows are connecting these lesser-developed economies to the larger global economy. There is still a real market demand for these currencies even though the volume is relatively low.

If you are new to the concept of Forex pairs, gaining an understanding of what constitutes a Forex currency pair is beneficial before diving into exotic pairs. Once you understand how typical currency pairs function, it becomes easier to understand exotic pairs.

Unique Characteristics of Exotic Currency Pairs

Volatility is one of the main concerns for traders. Prices can fluctuate sharply over a short period of time, and sometimes there is no advance notice of this change in trend. Although this creates opportunities for traders to profit from these price movements, it also increases risk to margin accounts.

Another major characteristic of these types of currencies is the lack of liquidity throughout the day. Because there are fewer active traders participating in these currencies, it may be more challenging to enter or exit a position at the specific price you desire. This particularly occurs when major news releases because slippage is generally more common among currencies with lower liquidity.

In comparison to the major currency pairs that trade at the highest volume, spreads tend to be much wider and the trade cost is higher. This higher cost may affect short-term trading strategies more than long-term trading strategies.

These currencies tend to be particularly responsive to local political news or events (i.e., political changes, central bank decisions, and economic instability) because of the small trader base that participates in these currencies.

Popular Exotic Currency Pairs in the Forex Market

Exotic pairs might not be traded commonly, but many of the most recognized ‘exotic’ currency pairs are well-known by the majority of experienced traders.

The majority of these exotic pairings involve the United States dollar and the currency of a country such as Mexico, South Africa, Turkey and Thailand. In addition to being widely discussed in relation to trading, the ‘exotic’ pairs have demonstrated greater consistency with respect to data availability and slightly higher liquidity compared to other pairs.

Furthermore, traders who monitor the global MACRO-ECONOMIC TRENDS typically gravitate towards these exotic pairs. Examples of the factors that influence price movements for these currencies are interest rates, inflation statistics and government monetary policies. Despite the fact that these exotic pairs are frequently discussed and traded, being popular does not translate to safety.

The volatility and behavior of the exotic currency pairs are quite different from those of the major currencies; therefore, the trader who wishes to trade these currencies must be prepared for a changing mindset.

Exotic Pairs vs Major and Minor Currency Pairs

Exotic pairs have less liquidity compared to both Major and Minor Pairs. Major Pairs offer a high level of liquidity because they are traded 24 hours per day with high volumes while Exotic Pairs do not.

Minor pairs fit between Major and Exotic Pairs as they include currencies of two strong economies, except the US dollar. Additionally, Exotic Pairs typically consist of at least one of the currencies where the country has an uncertainty (politically or economically).

Costs associated with Exotic Pairs will also generally be greater than those associated with Major Pairs, including trading fees, spreads, and in some cases, even swap rates. Traders may see greater movements in price for Exotic Pairs; consequently, some traders feel attracted to Exotic Pairs due to their additional complexity.

What Drives Exotic Currency Pair Prices?

Many factors contribute to this. Local conditions will have a large impact on traders’ perceptions of future prices.

Inflation, interest rates, and employment in developing economies can quickly change how traders perceive the economy and therefore how much they want to trade. Additionally, local economic conditions will directly affect trader sentiment and thus the price of assets associated with the local economy.

Politics also influences traders’ decisions than many believe. Political events such as Elections, Policy Changes, Geopolitical Events, etc., can cause immediate and sharp price movements, even if no changes occur on the Global scale.

The global risk appetite factor also drives this. As global markets become more confident in their future, they tend to send capital toward higher returns and emerging currency pairs. Conversely, as fear grows in international markets, capital tends to flow back toward safe-haven currencies such as the US dollar.

For these reasons, context is everything when trading currency pairs. Currency pairs are not moving in a vacuum, they will react simultaneously to local and global forces.

How to Trade Exotic Currency Pairs Successfully

To be successful, you must first be prepared. This will require understanding not only the chart but also the country behind the currency and what is happening in that country from an economic standpoint. An economic calendar is important to have because one interest rate decision can cause the entire direction of the trade to change.

The position size should be kept at a conservative level; larger price fluctuations mean that a smaller position size may produce a better result. The term trading exotic currency pairs comes into play at this point, as it relates to timing and making well-informed decisions rather than just making frequent trades.

Using reliable tools, such as having stable trading environments and being on the right platforms, will be crucial. Such tools help to reduce the likelihood of encountering execution-related problems and allow for better control of your trading.

Who Should Trade Exotic Currency Pairs?

For those who have experience in trading, these pairs are most often a better fit. If you have a solid grasp of both risk management and how the market is structured, you will have an easier time anticipating their actions.

For traders who have a keen interest in global economics, these pairs may be ideal. The majority of traders often find these markets to be interesting rather than daunting if they take an interest in current events or economic trends.

The key to trading these pairs is to exercise patience. It is impossible to make quick decisions or react emotionally in this environment.

While those new to trading may benefit from watching how these pairs behave prior to risking actual capital, they may also learn from an experience without risking any money trading these pairs.

Costs & Trading Conditions for Exotic Pairs

The cost of trading with a large spread is typically the most obvious form of additional cost incurred by a forex trader. Higher spreads generally relate to lower liquidity.

In addition to higher spreads, many brokers set higher levels of margin and limit the leverage that their clients can use. These controls are necessary in order to manage the risks associated with trading forex.

The speed at which an order is executed will be determined, to some degree, by the account type you use with the broker. Some brokers may set different execution speeds for different types of accounts, for example, a metatrader5 account vs cTrader Accounts.

Before executing any trades, be sure to review the trading terms and conditions closely to ensure that you are aware of any restrictions or limitations that will affect your trading. The small differences in trading terms and conditions can accumulate over time and result in significant differences in your overall profitability.

Common Mistakes When Trading Exotic Currency Pairs

There are traders who make mistakes by treating these pairs as if they were major currencies; similar approaches do not, always, produce similar results.

Another common mistake is ignoring fundamentals. Often the effect of local news will override technical analysis without the trader selecting good chart patterns for support.

Over-leveraging is also one of the mistakes traders make. The temptation to utilize more leverage due to larger price movements may cause the trader to over-leverage.

Finally, some traders will not realize that the daily spread of a new currency pair will cause their profits to be eaten away over time, therefore not doing their due diligence will not guarantee them success but it will enhance their possibility of winning.

Conclusion

Forex has a unique layer of “exotic currencies”. These currencies provide insight into economics, risks & opportunities outside of the major trading charts.

They can’t be judged as either good or bad, they’re just different. What is really important is being able to understand that.

If you can take the time to learn, stay patient, and respect risk, you will gain considerable knowledge about how the global finance system works through these markets.

By approaching them in the appropriate way, these currencies are no longer so “exotic” and become another useful tool in a thorough trading arsenal.