Forex Exotic Currency Pairs Definition And Trading Rules
An exotic currency pair is typically a combination of the currencies of an emerging economy and an advanced economy. Such pairs are usually characterized by increased volatility and lack of liquidity.
One of the most basic aspects to Forex trading that beginners should strive to understand is what a currency pair is, and what the three different types of currency pairs are. Of the three types - major, minor, and exotic - exotic pairs are perhaps the most unique, though the least frequently traded. Exotic pairs, as the name suggests, are unlike other types of currency pairs, behave differently, and are not as common. In this article I’ll be looking at what exotic currency pairs are, explaining how they are different to major and minor pairs, and analyzing the advantages and disadvantages of trading them.
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One of the most important yet basic things that a novice trader must understand about Forex is what currency pairs are, how to read them, and what different types of currency pairs are. Firstly, let’s look at what a currency pair is.
Currency pairs are a set of two currencies that are exchanged for each other, making a pair. Currency pairs are made up of a ‘base currency’ and a ‘quote currency’. When you open a position on a currency pair, you are buying the base currency and selling the quote currency. All currency pairs will only ever involve two currencies, and are written as XXX/YYY.
The base currency is on the left side of a pairing and represents how much of the quote currency is needed to buy one unit of the base currency. The quote currency, or sometimes ‘counter currency’, is on the right side of a pairing, and denotes how much of the quote currency needs to be sold to purchase one unit of the base currency. The quote currency is used to value the base currency. For example, reading a EUR/USD pairing at 1.35 means that to purchase 1 unit, a buyer must pay $1.35. Alternatively, if they want to sell 1 unit, they will receive $1.35.
There are three types of currency pairs that traders should be aware of. Each type of pairing has its own unique features, advantages, and disadvantages - but we’ll look at those in more detail further on. The three types of currency pairs are as follows:
Major Pairs
Major pairs consist of the U.S. dollar paired with another major currency from a developed nation. The major currencies include EUR, GBP, JPY, CHF, CAD, AUD, and NZD. Major pairs are the most popular choice out of the three types and hold the top positions when ranked by trading volume.
Minor Pairs
Minor pairs, sometimes called ‘cross pairs’, are made up of any two major currencies, but do not include USD. For instance, the British pound and Euro (GBP/EUR) form a minor pair, as do the Australian Dollar and Japanese Yen (AUD/JPY). The most popular of all of the minor pairs are ones featuring the British Pound, Euro or Japanese Yen (GBP, EUR, or JPY).
Exotic Pairs
Exotic pairs are any currency pairings that feature one of the 8 major currencies, alongside an ‘exotic’ currency from an emerging economy, such as Thailand or South Africa. Examples include a pairing of the U.S. Dollar with the Hong Kong Dollar (USD/HKD) or the Swiss Franc and Swedish Krona (CHF/SEK). Less commonly, an exotic pairing can be made up of two exotic currencies, such as the Mexican Peso and South African Rand (MXN/ZAR) or Brazilian Real and Turkish Lira (BRL/TRY).
Key differences between exotic, major, and minor pairs
Different types of currency pairs behave differently in the Forex market. As major pairs are the most popular, their price action will look completely different to that of an exotic pairing. As the least popular of the three types, exotic pairs are more thinly traded and therefore less liquid. The key differences between exotic major, and minor pairs are:
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Currencies Involved: Major pairs all feature the U.S. Dollar, and another major currency. Minor pairs feature two currencies of major economies, while exotic pairs involve a major currency and an emerging economy’s currency
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Behavior: As major pairs involve major global currencies, they are influenced by global events, making them more stable. They have the most predictable behavior, followed closely by minor pairs. Exotic pairs are the most volatile of the three, and exhibit the most unpredictable behaviors due to the unique economic and geopolitical factors that dictate their movement
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Liquidity and Trading Volume: High liquidity and trading volume makes a currency pair more stable, as the trades of individuals won’t significantly influence its movement. Major pairs have high liquidity and substantial trading volume. Minor pairs have moderate liquidity but lower trading volume. Exotic pairs have the lowest liquidity and trading volume, potentially leading to wider bid-ask spreads
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Global Economic Significance: Changes in major pairs can signal broader shifts in the global economic landscape, as they are from global financial centers. Changes in minor pairs can reflect regional economic trends. Exotic pairs, however, represent currencies with less global economic influence. Movements in exotic pairs are influenced by unique factors related to the specific countries involved
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Risk profile: Major pairs are the least risky to trade due to their stability and high liquidity. Minor pairs feature moderate risk, but balance stability with the potential for more significant price fluctuations compared to majors. Exotic pairs have the highest levels of risk, and traders may experience larger and more unpredictable price swings
For a deeper dive into the differences into how to trade different currency pairs, see Traders Union’s article on the subject.
Due to the significantly higher risk involved in exotic pairs, less predictable behavior, and lower liquidity, it’s advised that only the most experienced traders buy and sell exotic currency pairs.
Beginners should stick to major pairs, or with a bit more experience, minor pairs, as detailed in our article about the best currency pairs for beginners in 2023.
Pros and cons of trading exotic pairs
Despite the lower liquidity and stability of exotic pairs, as well as their higher levels of risk, there are still some benefits to trading them. Let’s look at some of the advantages and disadvantages of exotic pairs:
👍 Pros
• 1. High Volatility and Potential Profits. Due to the higher volatility of exotic pairs, traders can capitalize on bigger price movements and possibly higher profits
• 2. Diversification. Trading exotic pairs diversifies a portfolio, reducing dependence on ‘mainstream’ currency pairs and providing exposure to unique economic conditions
👎 Cons
• 1. Increased Risk. The higher volatility of exotic pairs introduces a higher level of risk. Sudden and unpredictable price movements can lead to larger losses if risk is not properly managed
• 2. Low Volumes. They have low trading volumes, which leads to wider bid-ask spreads, difficulty in executing trades, and reduced price transparency. Large trades in low-volume markets can cause substantial price movements
• 3. More Expensive. Wider spreads and lower liquidity contribute to higher transaction costs when trading exotic pairs. Traders may face higher fees and potentially incur more significant slippage
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FAQs
What are some examples of exotic currency pairs?
Any pair involving an exotic currency, such as EUR/TRY, GBP/RUB, and MXN/ZAR.
Are exotic currency pairs more volatile than major pairs?
Yes, exotic pairs tend to be more volatile due to their lower liquidity, wider spreads, and sensitivity to economic or political factors in less stable economies.
Should beginners trade exotic currency pairs?
It's generally advisable for beginners to start with major and minor pairs before venturing into exotic pairs due to their higher risk profile.
How can traders manage the risks associated with exotic currency pairs?
The risks imposed by trading in exotic pairs can be mitigated by applying carefully planned risk management strategies. All risks can be controlled to some extent using risk management.
Glossary for novice traders
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Broker
A broker is a legal entity or individual that performs as an intermediary when making trades in the financial markets. Private investors cannot trade without a broker, since only brokers can execute trades on the exchanges.
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Trading
Trading involves the act of buying and selling financial assets like stocks, currencies, or commodities with the intention of profiting from market price fluctuations. Traders employ various strategies, analysis techniques, and risk management practices to make informed decisions and optimize their chances of success in the financial markets.
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Exotic Currency Pairs
Exotic currencies are currencies from countries with smaller or emerging economies, and they are less commonly traded in the foreign exchange market compared to major currencies like the US Dollar, Euro. These currencies are often considered exotic because they are not as liquid or widely used in international trade and finance.
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Volatility
Volatility refers to the degree of variation or fluctuation in the price or value of a financial asset, such as stocks, bonds, or cryptocurrencies, over a period of time. Higher volatility indicates that an asset's price is experiencing more significant and rapid price swings, while lower volatility suggests relatively stable and gradual price movements.
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Investor
An investor is an individual, who invests money in an asset with the expectation that its value would appreciate in the future. The asset can be anything, including a bond, debenture, mutual fund, equity, gold, silver, exchange-traded funds (ETFs), and real-estate property.
Team that worked on the article
Jason Law is a freelance writer and journalist and a Traders Union website contributor. While his main areas of expertise are currently finance and investing, he’s also a generalist writer covering news, current events, and travel.
Jason’s experience includes being an editor for South24 News and writing for the Vietnam Times newspaper. He is also an avid investor and an active stock and cryptocurrency trader with several years of experience.
Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO).