Author: Shams ul Zoha
How to trade exotic currency pairs?
Exotic currency pairs have a major economy's currency alongside a weak one, or two poor ones against each other. Some good examples are USD/MXN, EUR/HUF, EUR/TRY, etc. The varying liquidity and volatility related to these pairs require that a trader change their trading approach if shifting from major or minor currencies. Understanding how exotics works can help you tank in a good number of pips, which may not be possible with other pairs. Our article will discuss how exotic currency pairs can be traded in the best possible way to avoid unnecessary drawdowns.
Economic factors to note
Exotic currency pairs are affected by similar economic factors to those that govern majors and minors. These include Gross Domestic Product (GDP), retail sales, interest rates, worldwide economic stability, political events, and the Consumer Price Index.
While many developing countries contribute to the list of exotic pairs, trading is mainly limited to a few notable ones, including the Norwegian Krone, Czech Koruna, Hungarian Forint, Russian Ruble, Turkish Lira, Chinese Yuan (Renminbi), Singaporean Dollar, Hong Kong Dollar, Thai Baht, Indonesian Rupiah, Indian Rupee, Mexican Peso, Brazilian Real and South African Rand.
Before picking on any exotic currency to trade, you must also understand what factors, other than economics, are involved in moving the pair. For example, the Mexican peso is a commodity-based currency that is governed by changing oil prices to some extent. This is because Mexico is the 9th largest oil producer in the world. Therefore, the petroleum status report released every week in the United States may affect the pair.
Exotic currency pairs provide a good amount of volatility but only during specific hours or periods. The ups and downs in the prices relate both to the base and the quote currency. The increased price fluctuations are because the trading volume is meager. Therefore, any incoming news or significant positions can move the instrument considerably. This higher volatility gives considerable opportunities for investors who like to have higher potential returns within a short period. But this also means that the risk on your executions will be greater.
Trading volume and spreads
The low trading volume contributes to a vast difference between the bid and the asking price. The spreads may start from 10 pips and can go up to as much as 700 pips. As a result, it might take some time for your trade to enter positive territory; however, the increased volatility may help you in this regard. The huge costs of trading exotic pairs might render them useless for a short-term approach. It would be better if a trader uses a swing or position trading, as higher time frames are less prone to fluctuations, and your trades will cover the spreads better.
Where can you trade exotic pairs?
Currencies of severely underdeveloped countries are only available with local brokers. International brokers include pairs with much better liquidity, e.g., USD/HKD and USD/SGD. Before opening an account, the exchange may require you to verify your credentials.
A few strategies for exotic currencies
Whether major, minor, or exotic, each currency pair has a specific behavior that a trader must understand adequately. We can, however, employ a few technical trading strategies on most exotic currencies.
Indicators and trends
A good trend trading strategy will allow you to ride with the big boys moving the pair. We can employ trading indicators to follow trends. For example, it is possible to use a moving average to indicate when the market is shifting from bearish to bullish.
Image 1: The cross-over between simple moving averages 9 and 21 on the daily chart on USD/TRY shows continuation and possible reversals. Be careful while using the MAs as they are a lagging indicator.
The famous price action may also work in this case. Having a proper knowledge about the charts is important in this regard. Seasoned traders will find it easier to implement this system on exotic pairs.
Image 2: A simple price action trade on the EUR/SGD chart at the daily time frame. The daily key level acts as a point of resistance where a trader takes a buy for a risk-reward ratio of 1:2.32.
As mentioned before, exotic currency pairs are also governed by fundamentals. Therefore traders can find news that will be catalysts for their swing trades. For example, during March 2020, the spike in the Mexican peso was due to the global decrease in demand for oil prices. Thus, any trader who speculated the event beforehand may have bagged a good number of pips.
Image 3: Depreciation of Mexican peso against the US dollar.
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