A currency pair is referred to as “exotic” when it consists of one major currency and one currency from a developing or emerging nation. An example of this is the USD/TRY, a currency pair that consists of the US dollar as the base currency and the Turkish lira as the counter currency. Another example would be EUR/MXN which consists of the Euro as the base, and the Mexican peso as the counter currency.
While trading with exotic currency pairs has the potential to [yield] higher profits due to the wider price fluctuations, they are much riskier to trade than a standard currency pair.
These pairs are prone to higher levels of price [volatility], and because they are not frequently found, do not provide a great deal of[liquidity]. They are also more expensive to trade due to higher commission or [margin] requirements, and also possess a wider spread than their traditional counterparts.
The counter currency in an exotic currency pair can originate from one of 150 emerging countries and trading is centred around 18major currency pairs.
Due to the counter currency in the exotic pair being that of an emerging or developing nation, price fluctuations are deeply driven by factors such as economic or political climate, the instability of which, often results in increased volatility in the price of the pair.
To illustrate the difference in liquidity between standard currency pairs and exotic pairs, it was reported that in one trading year, the EUR/USD accounted for 23.1% of daily foreign exchange transactions whilst USD/TRY only accounted for 1.3%. This much lower level of demand means that it can prove harder to exit a trade. However, the liquidity of an exotic currency pair is often increased when a major currency is used as the base currency.
Key takeaways:
- An exotic currency pair consists of one major currency and a counter currency from a developing or emerging nation
- The profits from trading an exotic currency pair tend to be higher, but so does the risk
- Risks include greater price volatility, lower liquidity, and higher trading costs