Forex Trading on the Exotic Side
10/17/2012 9:00 am EST
Tyler Yell of DailyFX.com explains why forex traders shouldn’t be afraid to trade the non-major currency pairs.
A trading strategy that doesn’t consider exotic or non-major currencies limits your exposure to many great trading opportunities throughout the year. Exotic currencies contain an unknown mystique that causes too many traders keep their distance from these great pairs.
However, there is a smart way to play these unfamiliar pairs that we will walk through in this article so you don’t get burned by their outrageous moves. By the end of this article, you will confidently keep exotic currency pairs in your rotation of set ups by seeking to trade their strong trends.
Let’s first discuss the first two reasons why traders stay away from exotics. When you understand these two reasons and their remedies, you will treat exotics like less of a lion and more of a kitten.
Reason One: The pip value is too low to be worth my time.
This problem is remedied by the second reason people shy away from exotic FX pairs.
Reason Two: These pairs move way too much to be worth my time.
It’s a fair point to be sure. As you can see on this 4-hour chart, the USD/ZAR has moved 9,450 pips since August.
Here are two commonly traded exotics and their respective Average True Range (ATR) over the last 14 periods as of October 10, 2012.
USD/MXN: 1,070 pips / day
USD/ZAR: 1,473 pips / day
Ok, so the moves are spectacular. But, how can I trade these exotics without getting skinned alive?
Welcome to the beauty of trade size. Trade size is a main indication of how much risk you’re taking on when entering a position. From experience, trade size is a top secret of old traders to stay in the game for many years. The following truism in trading is alive in exotics FX as in any other FX pair. To some, you can say it is true with me. To others, this will be a revelation of sorts:
There are old traders and there are bold traders, but there are very few old, bold traders.
NEXT PAGE: The Nuts and Bolts of Trading Exotics |pagebreak|
What you’ll soon learn is that reason one is the remedy to reason two as to why you should consider exotics in your trading plan. In other words, the pip cost is the reason why these huge moves don’t scare traders who trade them.
On a 10k trade, the pip value of the USD/MXN = $0.08 per pip. This is what it will look like on your platform:
This means the average daily volatility on a mini lot would equal roughly $85.60 p/l to your account. If that’s too much for you, you can trade smaller than a mini lot to decrease your exposure further.
One of the mystiques lies in calculating the risk and reward of the pair given the small pip value and outrageous ATR. Once you uncover the mystery you will recognize and incorporate these pairs into a strong trading plan.
So when trading these pairs, we need to treat them with respect because of their ATR. The best way to keep these pairs a part of your trading plan while respecting their volatility is with a small trade size.
Once you’ve determined the trade size and therefore the pip value, you can set up your trade with a strong 1:2 risk:reward ratio like we always recommend.
These large moves with a small pip cost can lead to wonderful trends and technical set ups that you would have missed out on if you were neglecting exotic currency pairs
Are There Any Other Opportunities When Trading Exotic FX Pairs?
There definitely are opportunities in addition to the big moves alone. Exotics like the Mexican peso (USDMXN), South African rand (USDZAR), and Nordic pairs (USDSEK & USDNOK) offer some of the highest interest rates and rollovers in the current global economy. Because rollover on the exotics can be so large compared to the major FX pairs, stay tuned for my follow up article dedicated to filtering trades in the direction of the positive rollover, also known as the Carry Trade.
Lastly, because this is an exotic pair, the margin is more than you would find on a major pair and the spread is significantly higher. As you’ve seen, it is not uncommon to see exotics move several hundred pips on a given day and the cost per pip is diluted, which is why it can still be a good trade if the technicals align.
Tyler Yell can be found at DailyFX.com.