Should you trade exotic currency pairs?

The chances are that you'll have built your trading success upon a clearly defined, robust strategy with which you're familiar and comfortable. It's an approach that makes plenty of sense, especially when you're finding your feet. But that's not to say that you shouldn't consider alternative options – and trading exotic currency pairs could be an avenue worth exploring.

As with any trading decision, it's not one to be rushed into or taken lightly. It requires careful analysis and research, because you're bound to be less accustomed to dealing with exotic currencies, their fluctuations and the factors that can influence those.

You're sure to experience a learning curve, and that process can start right now. Here, we'll provide information on exotic currency pairs, some common examples, the various strategies that you can implement and what you need to consider before you get started. Read on to find out more with FXCM.

What are exotic currency pairs?

An exotic currency is one which is not commonly traded on a global scale – unlike major currencies such as the US dollar, Euro or Japanese yen. Exotic currencies are typically linked to countries where the market is developing. This can make them illiquid as well as being much more volatile than the traditional powerhouses, which offer a greater degree of stability to forex traders.

But the term 'exotic currency pair' can prove slightly misleading, as a pair consists of one exotic and one major currency – rather than two of the former.

Examples of major currency pairs

Some of the most commonly traded currency pairs are:

• US dollar/Euro (USD/EUR): The sheer size of the two largest global economies means that daily trading volume is comfortably higher than any other pair.
• US dollar/Japanese yen (USD/JPY): This pair can offer traders an insight into the economic health of the Asian region as a whole.
• British pound/US dollar (GBP/USD): Sometimes known as 'the cable' – a nod to the transatlantic wires that connect the two countries – it's often used as a global benchmarking pair.
• Euro/Japanese yen (EUR/JPY): Policy changes from the European Central Bank and the Bank of Japan should be closely monitored as a key factor in influencing this pair.
• Euro/British pound (EUR/GBP): Geopolitical issues, such as the UK's recent exit from the European Union, impact these two major economies.

Examples of exotic currency pairs

There are plenty of examples of exotic currency pairs, including the likes of:

• US dollar/Polish zloty (USD/PLN)
• Euro/Norwegian krone (EUR/NOK)
• Japanese yen/Turkish lire (JPY/TRY)

The above are just three examples but, if your strategy dictates, it may be possible to pair any exotic currency with a major one. It's important to remember, however, that exotic pairs are traded far less frequently than those including two major currencies.

We can look at the Bank for International Settlements' Triennial Central Bank Survey to further illustrate this point. Data released in 2019 reveals that USD/EUR made up almost one-in-four (24%) of daily forex transactions. In contrast, the USD/PLN pair – one of the examples mentioned above – accounted for just 0.4%.

Strategies for trading exotic currency pairs

As is the case with any form of trading, there is no method that can guarantee success when it comes to exotic currency pairs. However, there are a few popular strategies that you can employ.

Breakout trading

This is where traders aim to capitalise on an opportunity by anticipating a future shift in pricing trends. Breakout trading is a proactive, rather than reactive, strategy and offers prospects in that you have the potential to get ahead of the curve. Common characteristics that could be an indication of a breakout include a surge in trading volume or increased volatility. These can both lead to the defining element of a breakout, which is a directional move in price.

Range trading

You can use range trading to predict how various exotic currency pairs will perform within certain support and resistance levels. These limits can be used to make decisions on whether to go long or short on a pair, and some traders adopt this strategy when the markets are stagnant. It's important for you to first define your range, which can be done by creating a trend line through the highs and lows recorded over a certain period of time. The next step is to set your buy and sell orders close to the relevant ends of the range.

Trend trading

Trend trading relies on a good deal of technical analysis and research. It's a longer-term strategy where positions are taken on price movements over an extended period of time. It's a tactic that requires a great amount of patience as well as the implementation of robust risk mitigation in the form of stop-loss orders and trailing stops. Trends can be identified by drawing lines that connect the extremes of the price movement – be they the highest peaks or the lowest troughs.

Why should you trade exotic currency pairs?

There are plenty of benefits to adding exotic currency pairs to your trading portfolio. The potential advantages include:

• Increased volatility: The price movements associated with exotic currencies tend to be much more volatile than those on major currencies like the US dollar or the Euro. The upside of this is that, if your trade pays off and things move in the direction you expect them to, it can enhance your profitability.
• Portfolio diversification: Exotic currency pairs can encourage you to broaden your own horizons as well as those of your portfolio. Increasing diversification can help to guard against risk because, if your portfolio is too heavily centred around one market or instrument, it can suffer heavily if movements in that sector go against you.
• Fewer market forces: Exotic pairs are not as heavily linked to other instruments such as bonds or stocks. This means that their performance is not as impacted by macroeconomics and you can shape your strategy with a more refined focus.

What you need to know before trading exotic currency pairs

All good traders know that there are no guarantees, even if you're vastly experienced in the world of forex. Exotic currency pairs offer plenty of opportunities but there are also factors that you need to take into consideration before adding them to your portfolio.

• Risk: While their increased volatility does mean scope to make profitable trades, the flip side is that the price fluctuations can move against you and magnify your losses.
• Illiquid: Because exotic currency pairs are less frequently traded than major ones, it is not always easy to find a buyer or seller to suit your needs. That could mean that, even though you've spotted an opportunity, you're left unable to get into or out of the position.
• Lack of information: When it comes to exotic currencies, there may not be the same wealth of material to base your research and analysis around. This could make it more difficult to shape a robust, well-informed strategy.

How to trade exotic currency pairs with FXCM

FXCM is one of the premier forex brokers, offering you access to a vast array of major and exotic currency pairs. Your strategy and choice of markets is entirely up to you and you can execute your deals using our flagship Trading Station platform or the likes of MetaTrader 4.

Not sure if trading exotic currency pairs is going to prove the right approach for you? You can try our demo account and build up your experience before venturing into the markets for real.

With FXCM, it's possible to trade exotic currency pairs via CFDs 24/5, so open your account and explore your options today.