Trading in exotic forex pairs has seen a sharp increase in popularity in recent years –for many people since they’re working remotely, it opens up previously unavailable avenues to make a profit off of buying and selling exotic currency.
The globalization of the market, the strengthening of less-known economies, and the advent of online exchange services have made it possible for individuals to enter the game, whereas utilizing exotic forex pairs was previously reserved for specialized traders only.
However, let’s start with the basic – what are exotic forex pairs? Exotic forex pairs are made when you exchange a major, established currency for a less-known, exotic one (usually from an emerging market), or vice-versa.
So, if you buy Vietnamese Dong using US Dollars, you’ve established an exotic forex pair.
Major, Minor, and Exotic Currency Pairs
Let’s take a more in-depth look at the classifications that are used in the foreign exchange market. Major currencies are the US Dollar, Euro, Pound Sterling, Australian Dollar, Canadian Dollar, New Zealand Dollar, Swiss Franc, and Japanese Yen.
Major forex pairs are the most traded currencies in the world and you get them when you pair the USD with the remaining seven major currencies.
Minor pairs, sometimes called cross currency pairs, are trading in the remaining seven major currencies with the exclusion of the USD. So, EUR/GBP, GBP/JPY, or any other combination of the given currencies are minor currency pairs, while EUR/USD, GBP/USD, etc. are major pairs.
There is a subset of the minor pairs called Euro crosses – it’s when a minor pair includes the Euro.
The third classification of currency pairs is the exotic forex pairs. Usually, it’s pairing one of the major currencies with a currency from a developing or emerging market. However, pairing two exotic currencies would also constitute an exotic forex pair, although that is a less common occurrence.
We should note that an exotic currency is not only a currency that has a low value compared to the major ones. While that is often the case, a currency will be considered exotic even if it has a higher value than a major one, but is not as well established among traders.
In essence, the classification of currencies is more of a hundreds-of-years-old popularity contest than anything else.
For instance, the value of the Kuwaiti Dinar is regularly higher than all of the major currencies, but it’s not considered one of the majors. On the other hand, many exotic currencies beat the Japanese Yen by a significant margin, yet the yen is one of the majors.
Just compare the two against the Dollar on any given day to see how much the actual value of a currency has to do with its classification.
Is Trading In Exotic Forex Pairs Legal?
As this is a common question, we should deal with it off the bat. In short, trading in exotic forex pairs is generally legal. There are no specific laws that restrict the exchange of foreign currencies in most countries.
Currency trading is regulated in general and you must follow the laws that apply to it (and some traders won’t follow the laws and regulations, making their actions illegal), but forex trading is not illegal per se.
Why Are Exotic Forex Pairs Risky?
Price movements for exotic forex pairs are more frequent and often in a wider range than for the majors or minors, and they lack market depth. Exotic currencies are also less liquid, so the combination of less liquidity and higher volatility exposes you to risks that you don’t have when you trade in the major or minor pairs.
Also, the price of the major currencies primarily depends on the health of the economy of the given countries and the interest rate differentials, while exotic currencies tend the heavily depend on the political and economic situation in their countries of origin.
As these countries often don’t have stable economies, an exotic currency can depreciate rapidly in situations of political or economic instability. This is something you’re highly unlikely to encounter if you trade in the major pairs.
Should You Trade in Exotics?
There’s no right answer to this question. You can apply the basic trading philosophy of any industry to find out if trading in exotic currencies is right for you. The price volatility of exotic currencies makes them much riskier to trade compared to the major currencies, but that same volatility allows you to make larger profits.
So, are you going for a steady profit and a lower chance of loss? Then, you should stick to the major and minor pairs. Do you want your trades to be riskier, but have larger profit margins?
In such a case, you could trade exotic forex pairs.
Which route you want to go is up to you, but you shouldn’t focus only on the potential gains and neglect the risks involved in trading exotics.
Tips for Trading in Exotics
First and foremost, you shouldn’t trade in exotics if you are inexperienced in currency trading in general. Because of the volatility, exotic forex pairs can be very profitable, but you need to have an in-depth knowledge (or an absurd amount of luck) of the exotic currency to make it work.
Further, depending on the country of origin, it can be hard to find reliable and timely sources you can use to make predictions regarding the future state of the exotic currency you are trading. If you are bilingual or have access to reliable domestic sources and follow the politics and economy of the given country, you increase your chance to buy and sell at the right time.
Second, it’s safer to pair an exotic currency with a major one, instead of another exotic one. For instance, the US dollar is so strong that it will in large part dictate the price of the pair. Thus, a trader who understands the dollar and can make proper predictions can trade numerous exotics and make substantial profits.
Finally, always check with your broker what they offer if you want to trade exotics. Exotic currencies are less liquid, meaning that there is less money circulating between them. This can make it hard to get in or out at the price you want for larger sums, so you should always know what your limits are.
Theory and proper predictions are all well and good, but none of it matters if you can’t get out when you want.
Exotic Forex Pairs Require Special Precautions
The final advice we have is that you shouldn’t trade in exotic forex pairs unless you are already an experienced trader or can easily deal with the potential losses. While exotics are more volatile than majors, allowing you to make a killing if you know what you are doing (and the risk involved makes the trading more fun), you should stick to the major pairs until you have some experience in currency trading in general.