In forex, currencies are classified in three groups, namely: major, minor and exotic currencies. The last group comprises illiquid and not popular currencies, not involved in consistent market activity, traded at high markup fees and in specific markets.
The list of exotic currencies may have variations in time, and typically includes: the Brazilian real (BRL), the Mexican peso (MXN), the Russian ruble (RBL), the Kuwaiti dinar (KWD), etc. As mentioned above, thin trading is characteristic of such currencies, and that is why market participants do not have vast interest in them.
Risks of forex trading in exotic currencies
Low liquidity is among the key risks involved in trading in exotic forex pairs. Due to the liquidity issue, these currencies are offered with larger spreads which directly affects the results of trades in exotics. Another hazard is the difficulty in tracking and predicting developments for countries which have exotic.
Although the potential for positive results are quite big, the downside of high mark-up fees charged by dealers reduces such profits. With fluctuations owing to political instability, forex trading in exotics becomes increasingly harder. A recent example is the fluctuation of the Russian ruble owing to the Ukrainian conflict.
Rewards of forex trading in exotic currencies
Forex trading in exotic currencies is characterized with high volatility, and with big and rapid price moves the profit margins could be quite big as well. Quoting the above example of the Russian ruble, traders who are on the right side of the RUB/USD, could have made rewarding profits in the last two and a half months. Another example can be given with the USD/INR (Indian rupee): in several years period, from 2008 to mid 2013, the rate in the two currencies marked a soaring of 39 to 69, equal to 77% in profit.
Direct purchasing of an exotic currency on the spot market is just one type of investment. Other ways include trading in futures and options. However, market players should be aware of the complexity of such products.
Who should trade in exotic currencies
Having in mind the above mentioned risks and rewards of trading in those exotic pairs, it should be pointed out that novice and short-term traders should stay away from them. They are not recommended for traders with very limited trading capital, either.
Forex trading in exotic currencies is recommended for experienced dealers who can capitalize on wider spreads to achieve profits. Long-term investors with sufficient experience, managers of international funds or investors seeking some diversity to their global investments could potentially benefit from trading in forex exotics.
Another type of investors who could take advantage of that type of trading could be individuals who have consistently followed the specific country and its corresponding currency, and who have a long-term investment potential.