Foreign exchange trading (forex) is one of the largest financial markets worldwide. Trillions of dollars of transaction occur in this market every day.
The most traded currencies on the Forex market are usually major currencies such as the US dollar (USD), the euro (EUR), the Japanese yen (JPY) and the British pound (GBP). Of course, exotic currencies, which are less known and less frequently traded in this market, also have a significant place.
In this article, we will cover the trading of exotic currencies and the opportunities and challenges of these transactions.
We can say that exotic currencies are usually the currencies of countries with developing economies. We can say that the main feature of these mentioned currencies is that their transaction volumes are low and their liquidity is limited. This feature can also lead to sudden fluctuations in the prices of exotic currencies.
For example, transactions with the Mexican peso do not have as high liquidity as the US dollar or the euro. We can say that this limited liquidity causes exotic currencies such as the Mexican peso to be more volatile and cause sudden fluctuations in their prices.
In the Forex market, exotic currencies are usually traded by pairing with a major currency. For example, currency pairs such as EUR/TRY (euro/Turkish lira) or USD/ZAR (US dollar/South African rand) can be called exotic currency pairs. When trading in these currency pairs, wider spreads and volatile price movements may occur compared to major currencies.
Here’s a list of common exotic forex pairs: (added: Koray)
Investors who want to trade in exotic currencies first choose currency pairs through a forex platform and can perform trading operations. However, we can say that such currency pairs have different dynamics compared to major currency pairs.
Here are some basic points to consider when trading with exotic currencies:
Liquidity
Exotic currencies typically have lower trading volumes, results in lower liquidity. This lower liquidity causes market makers to set wider spreads, meaning the difference between the bid and ask prices becomes larger. In other words, the gap between buying and selling prices is generally wider compared to major currency pairs.
Volatility
Price fluctuations can be sharper in exotic currencies. Economic and political uncertainties can cause exotic currencies to suddenly depreciate or gain in value. For example, a political crisis or an economic shock in a country can also lead to large fluctuations in the country's currency.
Costs
The cost of trading in exotic currency pairs is higher. This is due to wider spreads and sometimes higher commission fees. Being able to afford to bear these costs in advance should be part of your strategy for trading with exotic currencies.
Trading with exotic currencies can offer investors extremely special opportunities. Of course, naturally, it should not be forgotten that these opportunities also often come with high risks.
Below are the main advantages that you may encounter when trading with exotic currencies:
High Return Potential
Exotic currencies can offer great earning opportunities in a short time, as they have high volatility. The most obvious example here is speculative investors. Such investors can make significant gains in the short term by taking advantage of rapid price fluctuations.
Diversification
An investor who wants to diversify his investment portfolio can include exotic currency pairs in the business. While constantly investing in major currency pairs is beneficial for liquidity, it can leave your portfolio vulnerable to market fluctuations. For this reason, you can use exotic currencies for portfolio diversification and reduce these risks.
Low Correlation
Exotic currencies have a lower correlation than major currencies. This creates an advantage for investors by offering an investment vehicle that does not move in the same direction as fluctuations in other asset classes.
Trading with exotic currencies has significant risks in addition to encountering opportunities. Understanding these risks allows you to make the right investment decisions. Here are the main risks of trading with exotic currencies:
Liquidity Risk
Due to the low trading volume, sufficient liquidity may often not be provided for transactions with exotic currencies. This may lead to investors being unable to execute their transactions at the price level they want.
Volatility Risk
Because exotic currencies are more sensitive to economic and political developments, sudden and large price movements may occur. These fluctuations may cause unexpected losses to investors.
High Transaction Costs
Wide spreads and high commissions on exotic currency pairs reflect the trading costs. In this way, your profit and loss ratios will also be affected.
Trading with exotic currencies on the Forex market requires investors to closely monitor economic and political developments. Because the value of exotic currencies is more affected by economic and political uncertainties in developing countries and can cause sudden price fluctuations. This results in higher volatility for exotic currencies, causing investors to experience unexpected losses or gains.
In this sense, when trading with exotic currencies, it is important to know the characteristics such as low liquidity and high volatility, to do risk management correctly, for the investor's strategy. Despite this structure, which may seem complicated, exotic currencies have the potential to provide high profits to investors with an accurate analysis and strategy.
Why is the liquidity of exotic currencies low?
These currencies typically have lower trading volumes, which leads market makers to set wider spreads, thereby reducing liquidity.
What is the return potential of trading with exotic currencies?
Due to high volatility, exotic currencies can make big gains in a short time. This potential for high returns also comes with significant risk. That's why it requires a good knowledge base and the right strategy.
How can I track exotic currencies on the Forex market?
Resources such as economic calendars, newsletters and market analyses are ideal for you to keep track of exotic currencies.
By what criteria is the value of exotic currencies determined?
The value of exotic currencies is variable according to various criteria such as economic indicators in that country, political stability, foreign trade balance and market sentiment. This is a phenomenon that needs to be constantly followed.
Which time zones should be preferred when trading with exotic currencies?
Usually, more trading can be carried out during market opening and closing hours, as well as during economic data releases and political developments. There is a significant movement in prices during these time periods. Investors may prefer time periods when volatility is high.
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What is Slippage in Forex? Price fluctuations and low liquidity periods in Forex can cause traders to execute transactions at levels different from their expected prices. This is where the concept of slippage comes into play.
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