What Does Exotics Mean in Trading?

Terminology is not consistent throughout the industry: a major is a pair consisting of currencies from the United States (USD), Great Britain (GBP), Japan (JPY), Europe (EUR), Australia (AUD), and Canada (CAD). An exotic is one of these (usually the USD or EUR) and one of the currencies shown in Table below. A pair comprised of two exotic currencies is called asking for trouble.
Exotics may also be called emerging, although there is not a strict one-to-one relationship between the two.

Exotic Currencies

Czech RepublicKorunaCZK
MexicoMexican PesoMXN
South AfricaRandZAR
YugoslaviaNew DinarYUD

Exotics are illiquid -- there is much less trading in them than in the majors or minors. The degree varies; the Polish Zloty is relatively liquid while the Thai Baht is very illiquid. The lack of liquidity means that pip spreads are high and large orders may be difficult to execute. Risks are greater, but so is profit potential.

Generally, the best fills are during the appropriate session relative to the exotic: European session for the Zloty, Asian session for the Baht. Fills are an issue for exotic traders and make short-term trading difficult because such costs must be figured into the equation. Fifteen pips on a 50-pip swing is too rich, but on an anticipated 200 pips, it may be livable.

Tip: Trading in the MXN, PLN, and TRY has increased considerably. Traded with the EUR or USD, there is enough liquidity and small enough trades to justify considering them if your trading method brings them to your attention.

The NFA has mandated that exotic currency pairs must be backed up with a minimum of 10 percent margin, yielding a maximum leverage of 10:1. Because of this limitation, many U.S. traders interested in exotics have moved their accounts to overseas broker-dealers to avoid this limitation. But this loophole is also closing rapidly.

Given a news event in an exotic country, prices may soar or dive, and exiting at any reasonable price may be difficult. Devaluations are uncommon, but when they do occur, overnight price changes of 20 percent or more can be either a disaster or a windfall.

Long-time traders will remember the devaluations of the Mexican Peso in the 1970s of 50 percent or more. Fortunes were made -- and lost -- literally overnight.
By Michael Duane Archer
Michael Duane Archer has been an active futures and FOREX trader for more than 35 years. He has worked in various advisory capacities, notably as a commodity trading advisor, registered SEC investment advisor, and branch manager for Heinold of Hawaii. He currently trades FOREX and futures and is involved in several technical analysis research projects.

Copyrighted 2016. Content published with author's permission.

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