By Sean Hyman Strange but true…
Many Forex traders – even professional Forex traders – don’t trade exotic currencies.
There are several reasons why. Some
traders simply don’t understand the profit potential of trading exotic
currencies from smaller emerging market countries.
| Emerging Market or “Exotic Currency” World… |
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Some traders like to stick to currencies
they know. So if they’ve been tracking the euro or yen for the last 10
years, they’re not willing to switch over to another batch of
currencies from smaller, more out-of-the-way countries.
But let me be the first to say…they
don’t know what they’re missing. As I’ve written here in FX University
in the past, the single most profitable trade of my entire Forex career
was an exotic currency trade.
In fact, the truth is if you catch a
trend in exotic currencies, these exotic currencies can regularly hand
out as much as five times more profits (or 500% more!) than regular
major currencies.
Reason: There are key differences between exotic currencies and regular majors that give them much more profit potential.
Just take a look at the charts below.
I’ve included a chart of a traditional exotic currency, the South
African rand (USD/ZAR), and a chart from the oldest major currency in
the world, the British pound (GBP/USD). While the squiggly lines on the
chart appear the same, there are several important differences that we
need to talk about.
South African Rand Makes Leaps…
…While the British Pound Strolls
The Strange But VERY Profitable Difference
The first thing traders notice about exotics is how many pips these amazing currencies can move on any given day.
The top chart shows that the South
African rand has an average daily range (ATR indicator) of 1,000 pips a
DAY during a normal trading year. Last year, during the credit crisis,
the South African rand was moving over 7,000 pips in a day!
During the same timeframe, the British
pound varied from moving 150 pips a day to 550 pips a day at the height
of the credit crisis.
So the actual number of pips these
currencies move per day is far more in the exotic pairs than the
majors…even volatile majors like the British pound.
Note: The reason for so
much volatility is exotic currencies traditionally have thinner volumes
than the majors. As such, news events move these exotic currencies more
than the major currencies.
Also, when you’re watching exotic
currencies, you’ll notice that these currencies tend to have a bit more
erratic behavior. That’s because traders in exotic currencies tend to
dive in and out faster. In other words, Forex traders want the higher
yields and pip movements that only exotic currencies can offer.
However, if traders sense trouble, they are quick to bailout of their
positions.
Exotics Actually Present LESS Risk to Your Account on a Pip-to-Pip Basis
Some currency investors are drawn to
exotics because of that very volatility, while others shy way from them
for that very reason. However, when it comes to exotics, the payout in
dollars in these currencies varies significantly from their pip value.
For instance, when you buy a major
currency pair like the euro (EUR/USD) or British pound (GBP/USD), you
usually risk about a $1 every time your pair moves a single pip in a
mini-account. You also earn about $1 a pip every time it moves in your
favor.
| You Risk Less In Dollar Terms With Exotics… |
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However, many exotics only pay out about
12 to 63 cents per pip of movement on average. So how many dollars
you’re actually winning or losing per pip is vastly different than a
major. Most traders don’t acknowledge that.
Therefore, your actual dollar risk is
“toned down” more than you think when you play exotics. Especially
considering you’re only risking 10-60% of a pip compared to a major
currency pair (in dollar terms).
So if you were trading the South African
rand, you would have to trade about eight times the typical number of
mini-lots in order to equal 1 mini-lot of the typical British pound
(GBP/USD) trade.
In the case of the Turkish lira, I’d
have to trade about twice as many lots as I did for the GBP/USD to be
about the same risk dollar wise.
False Argument Against Exotics: The Spread Is Too wide! Wrong!
Another huge difference at first glance is the pip spread difference between the major currency pairs and the exotics.
And yes, there is a big difference in pips.
The spreads on exotics may be between 50
– 200 pips vs. majors being 2-5 pips for instance. However, when you
convert those “exotic pips” into dollars, you’ll find that the cost is
about $24-$31. Yes, that’s more than the majors BUT it’s not nearly as
much as it sounds when we were talking about the number of pips that it
cost per trade.
Now some argue that they wouldn’t trade
an exotic pair due to that cost difference because a major pair would
be $2 to $5. However, again, they’re not considering how volatile, and
how potentially profitable exotic pairs can be.
Many
of these exotic pairs can move 500 to 3,000 pips in a day. So just like
you can cover the 2-5-spread cost in a major currency pair that moves
180 to 250 pips in a day, you can do the same thing with an exotic
pair. Any currency pair that moves 500 to 3,000 pips in a day can
easily erase its 50-200 pip spread cost.
The point being…an exotic pair with a
high pip spread is also volatile enough to cover that spread cost and
then some. In fact, an exotic currency can quickly cover its cost just
as fast as the lower volatile majors cover their spreads.
So exotics have higher volatility, higher spreads, YET the pip cost is lower. That helps lower the dollar amount of the spread.
Another bonus: The daily interest earned
on these pairs is generally significantly higher. So if you call the
direction right and earn significantly more interest along the way, it
does help to compensate for any added risk.
Fundamentals Aside, You Need to Watch Investor Sentiment!
One final difference in exotics over the
majors is the ability to get fundamental data on the currency. Oh yeah,
you can get it from their central bank’s site. And you can get some
info from Bloomberg, etc.
But other than that…it’s sometimes hard
to gain all of the fundamental data that you can readily get from a
major industrialized country.
However, with that said, the main, big
overriding factor with exotics is usually how risky investors are
willing to be. When economies are recovering or in a boom, exotic
currencies tend to push higher (pushing the USD/ZAR, USD/TRY, etc.
downward as the foreign currency rises up against the dollar).
But, when “times are tough” around the
world and investors get cautious, the exotics are some of the first
ones they run from (which gives a great tradable opportunity too as
these pairs shoot up as they run to the dollar).
So in either case, exotics can be a
great trade. Indeed, they can be five times more profitable than
majors. Right now, may be the best time to trade them…as economies are
pulling out of a recession and stock markets are showing signs of
recovery again.
Happy Trading!
Sean Hyman, aka Professor FX
P.S. BIG NEWS: Our Exotic FX Alert –
that regularly averages as much as 230% winners – is finally open to
new traders. Get all the details here.
Why the Ruble Is Heading South…
At
this point, everyone has already accepted that the global credit crunch
fallout has hit Turkey rather significantly. Indeed, the economy is
expected to decline by 4-5% in 2009, which is higher than previously
estimated (2% by the World Bank).
Of
course, the IMF won’t offer a flexible credit line without strings
attached. If Turkey accepted, there would be regular stringent reviews
of the line of credit. That could hamper Turkey’s growth and
flexibility in the future.
In
the first half of June, commercial surplus was driving the net FX
flows. That surplus actually amounted to $866 million, which was four
times larger than the net financial outflow right now (or $205 million).
Indeed, that’s why I recently recommended our 
You
see, a lot of Forex trading (especially in the short-term), involves
looking at a chart and noticing trend patterns in specific currencies.
Once you notice these trends, you can draw trend lines, look at
support/resistance lines, etc. But that all takes a little getting used
to if you’re still a beginner.
