When you start trading in the currency market, you’ll notice that many available options are traded in pairs. For example, EUR/USD, GBP/USD. With some additional research, you’ll discover that all these currencies hold different potential and value in the market, so they’re divided into several categories. Majors are the most traded of all the options, while exotic combines one popular currency and another less common one. There’s a lot to learn about trading currency pairs in the foreign exchange market, and we’ll be discussing what every trader should know when it comes to major and exotic assets.
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Major Currency Pairs: Characteristics and Volatility
Major currencies are the most traded and popular in the foreign exchange market. This is primarily because they consist of the powerhouses in the global financial scene. We have the likes of USD, GBP, and EUR in this category. These classes of assets make up most investments, constituting pairs like EUR/USD, GBP/USD, and AUD/USD. They amount to about 75% of all trades.
Two major characteristics of these pairs are high liquidity and average volatility. Their popularity makes them easily tradable and attracts more volume. The liquidity also makes it easy for traders to buy and sell assets without delays that might lead to possible losses. Also, because they have a long-standing history in the market and are highly reliable, these pairs are seen to have the least volatility.
Exotic Currency Pairs: Characteristics and Volatility
Exotic forex trading pairs combine emerging currencies with significant markets, such as USD/SGD. Their characteristics are quite distinct from the majors, mainly because they are highly volatile and have higher risks. They are also less popular and commonly traded than other alternatives, making them lower in liquidity.
However, one of the perks of this category of assets is that their trading pair offers high interest rates, making them more profitable for traders. Below are some lists of common existing exotic currency sets in the market:
- USD/SGD
- USD/NOK
- GBP/CZK
- EUR/PLN
- CAD/SDP
Drivers of Volatility in Major Currency Pairs
Major currency pairs are the least volatile options in the market today. This is mainly because most assets are seen as more stable alternatives in the foreign exchange scene.
For instance, the U.S. dollar, Swiss franc, and Japanese Yen are considered safe-haven assets in the space because of their strong liquidity and good political positioning. The solid monetary policies and economic conditions of these countries also contribute to the strength of their money, ultimately making them a less risky choice for market participants.
Drivers of Volatility in Exotic Currency Pairs
Conversely, exotic pairs have opposite standings compared to the major currencies. They are volatile and less traded due to the fragile nature of the countries’ economies. It’s no news that a country’s economy hugely impacts its currency, and the narrative is no different for exotic currencies. Many countries are developing, with less stable economic conditions and less reassurance of stability for traders.
Comparison of Volatility Characteristics
Volatility affects currencies in several ways, from risk perception to profitability and market sentiment. Based on their volatility, let’s look at some of the characteristics of exotic and major assets.
Wider and Tighter Spreads
The difference in the buying and selling pairs for significant currencies is negligible because they are easier to work with when opening or closing a position. They are more liquid, and there is always a guarantee of a buyer or seller whenever you need one.
The reality is quite different for exotic assets, and there might be wider spreads. Since the liquidity here is low, the difference in buy and sell prices is expected to be much higher in most cases.
Trade Level
Exotic currency pairs are thinly traded with relatively low activity, while majors are sold or bought heavily, and more traders have them in their portfolios.
Risk Perception
It is common knowledge that highly volatile assets come with higher risks, so exotics might not be your safest bet as an investor. Majors are less risky and safer alternatives for traders with a low-risk tolerance.
Case Study: Trading a High Volatility Currency Pair
A practical example of a high-volatility currency pair is the USD/CAD trade on August 18, 2021.
The market conditions at the time were unstable due to a sudden rate hike by the Bank of Canada, solid Canadian economic data, and ongoing global trade tension. Canada also had favourable economic climates, such as rising oil prices and exports. This market condition indicated that CAD could strengthen over USD at the time, and technical indicators also supported this claim.
Most trade setups went short on USD/CAD at 1.2840, with a stop loss around 1.2910 and a take profit limit at 1.2740. The outcome revealed that USD/CAD dropped to 1.2740 within 2 hours of the trade, resulting in a 100 pip profit.
Looking at this scenario, the volatility of this pair created a high-profit potential, and traders also took advantage of economic positioning and technical indicators. Volatile markets come with risks and exciting potential and could be profitable if you conduct solid market research.
Key Takeaways for Trading Major and Exotic Pairs
When considering what to invest in, the primary thing to note is that majors are great for making up most of your portfolio, and exotic pairs are a perfect alternative for minor diversification. You should have a solid trading portfolio as long as you learn to balance volatile assets and more stable alternatives.