The vast majority of traders will start of their forex trading journey trading major currency pairs. These are the most traded currency pairs in the world and include pairs such as the Euro versus the US dollar EUR/USD, Japanese Yen versus US dollar, JPY/USD and Australian dollar versus the US dollar AUD/USD among others. Major pairs include the US dollar against another major currency and are characterized by high liquidity and tight spreads.
After gaining some experience some trades will feel the need to experiment. This can sometimes mean a shift of focus towards exotic currencies.
As the name suggests, these are currency pairs which are not frequently traded. These are currency pairs which often involve the US dollar versus a currency from the developing world, often Asia, Africa or South America. For example, the US dollar versus the Mexican peso, the Russian Ruble or the Turkish Lira.
These pairs in general are not closely followed by analysts and are not heavily traded making them notoriously illiquid. The developing world currency is often linked to a country which experiences economic or political uncertainty and instability this increases the instability and volatility of the currency.
However, this high volatility is what can attract the eye of some traders. Keeping in mind the adage “high risk, high reward”, some traders can erroneously believe that trading exotic currencies could be an easy way to make a quick buck. This couldn’t be further from the truth, there is a much higher chance of a quick dabble in exotic currencies wiping out a large percentage of your account than helping make a fortune. A move into these pairs must be for the right reasons and with a solid amount of information over what you are trading.
These are the key disadvantages to keep in mind if you are tempted to move into exotic currency pairs:
Expensive to trade
Given the low liquidity of exotic pairs, they often have a very wide bid / offer spread. Whilst major pairs often have a spread of just a few points at the very most, exotic pairs, on the other hand can commonly reach a spread of 50 points. Given that the spread is a principal cost involved in trading, the higher this cost is, the more it eats into any potential profits.
Secondly given the highly illiquid nature of exotic currency pairs getting in and out of trades can involve large amounts of slippage. This adds to the expensive nature of trading these pairs.
Lack of information
With so few trading and following these currency pairs, analysts and researchers don’t spend a great amount of time on them either. Research tends to be limited and the research that is available can often have a significant bias to it. This makes doing research for trades extremely challenging and then it’s difficult to know whether you can trust the information you do have. In such circumstances it is tempting just to drop the trade.