Trading exotic currencies offers great opportunity for profits and also substantial risk of loss. Exotic currencies are usually illiquid, have high cost of carry, are not backed by secure political and financial environments and usually experience volatile trade with wide spreads. For these reasons exotic currencies are not easy to trade but profit potential can be quite large. Nothing worth doing comes easy does it?
What is an exotic currency?
An exotic currency is one not commonly or actively traded on foreign exchange markets. Exotic currencies are usually from emerging markets or developing countries in Asia, the Pacific, Middle East and Africa. Most traders when they think of the Forex markets think of the major currencies which are the euro yen sterling and Swiss franc. Or minor currencies which include the Canadian dollar the Australian dollar New Zealand dollar. The major and minor currencies are listed on numerous Forex platforms and generally have high volume active trade. In contrast, exotic currencies are usually thinly traded markets lacking depth and volumes tend to be quite low.
Illiquid
One of the major challenges in trading an exotic currency is the market is usually illiquid, and has a high cost of carry. An illiquid market is one that has little volume traded. Cost of carry refers to cost of holding a currency position. If you buy the currency, the cost of carry is the interest paid on a margin account. If you short a currency the cost of carry is the cost paying dividends or opportunity cost. Illiquid markets are often hard to enter and exit without substantial cost. Higher costs and difficulty of entering and exiting exotic trades can reduce your profit potential and longevity of your trading.
Trading is not secure
The political, economic and financial environment for exotic currencies can change quickly. Governments fall, economies experience boom and bust cycles and the financial markets lack depth. These factors can cause a currency to rapidly rise or fall in value and move quickly without notice. This can make it difficult to manage risk and create great opportunity for reward. Trading exotic currencies is inherently more risky than trading the major or minor currencies.
Wider spreads and increased volatility
The spread is defined as the difference between the bid price and asked price for currency. The spread represents the difference between what a market maker will give to buy from a trader and what the market maker will take to sell to a trader. The spread for major currencies runs 1 to 4 pips. The spread for the minor currencies is a bit wider sometimes as much as seven or eight pips or more. Spread for exotic currencies can be five time as wide or more depending on market conditions. The combination of illiquidity and lack of secure markets will greatly increase volatility of exotic currency price action. Increased volatility is key to risk and reward in trading exotic currencies.
Why you need to know about exotic currencies
Exotic currencies are illiquid, lack market depth and trade at low volumes. It can be expensive to trade exotic currencies. With that warning, if you look around the globe you will find politically and economically fragile countries where a financial crisis may be brewing .This could create tremendous opportunity to take advantage of trading in an exotic currency. Major example of this type of crisis is the Mexican peso crisis in 1994 and the Asian contagion crisis in 1997. During these crises the Mexican peso and Asian currencies fell sharply in a short period of time. Over the last few months volatility has been unprecedented in the Forex markets and emerging market currencies . Because of this volatility some of the biggest trading opportunities may still be presented in exotic currencies.
Here is a table of some of the more active exotic currencies.
| AED |
United Arab Emirates Dirham |
ARS |
Argentinean Peso |
BRL |
Brazilian Real |
| CLP |
Chilean Peso |
CNY |
Chinese Yuan Renminbi |
CZK |
Czech Koruna |
| EGP |
Egyptian Pound |
HKD |
Hong Kong Dollar |
HUF |
Hungarian Forint |
| IDR |
Indonesian Rupiah |
ILS |
Israeli Shekel |
INR |
Indian Rupee |
| IRR |
Iranian Rial |
ISK |
Icelandic Krona |
JOD |
Jordanian Dinar |
| KRW |
South Korean Won |
KWD |
Kuwaiti Dinar |
MXN |
Mexican Peso |
| MYR |
Malay Ringgit |
PHP |
Philippine Peso |
PKR |
Pakistani Rupee |
| PLN |
Polish Zloty |
RUB |
Russian Rouble |
SAR |
Saudi Arabian Riyal |
| SGD |
Singaporean Dollar |
THB |
Thai Baht |
TRY |
New Turkish Lira |
| TWD |
Taiwanese Dollar |
ZAR |
South African Rand |
ZWD |
Zimbabwe Dollar |
Test your knowledge
- Exotic currencies are_____ traded and______.
- lightly, liquid
- heavily, liquid
- thinly, illiquid
- Spreads for exotic currencies are____then the major currencies.
- narrower
- closer
- wider
- Political, economic and financial environments for exotic currencies can change quickly making it difficult to manage___.
- timing
- emotions
- risk
- True or false
Increased volatility is key to risk and reward in trading exotic currencies.
Answer key
- c, thinly, illiquid
- c, wider
- c, risk
- True
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