An area of trading really catching the attention of private investors in recent years is the currency market. Foreign exchange is the largest market in the world offering tight spreads, 24 hour availability and plenty of volatility so it is not difficult to understand why this is seen as the first destination for many starting out trading.
When we talk about forex, focus tends to be on the major currencies – the likes of the pound, the US dollar, the euro and the yen and so on. But there’s a whole world of other currencies out there should the fancy take you – if a currency exists, chances are it can be traded against another currency. The non-mainstream currencies tend to be referred to as ‘exotics’ and we will explore the pros and cons of going somewhat off the well-beaten track by speaking to some trading experts.
What to watch
The first question is what markets to watch? A quick Google search suggests there are around 180 currencies recognised by the United Nations – that would be a lot of charts to go through every day. Not all of these will be tradeable but that still leaves an unmanageable number of markets for the average private investor to keep an eye on. Over to our experts.
Brenda Kelly, chief market strategist at IG suggests linking your exotic currency interest to other markets. ‘An example would be the Russian rouble; you’d be interested in how oil is doing because of that correlation, or vice-versa, the South African rand’s correlation to gold. It’s advisable to keep either the GBP or the USD as the other side of the pair, this helps to ensure that information pertaining to one side of the trade will be fairly regular and easily accessible.’
This is an approach that Bryan Seegers, ADS Securities’ director of eFX pricing and execution agrees with, citing the Russian Rouble and also the Chinese currency (CNH) as two to watch due to the importance of their economies.
‘The CNH, the ‘free flowing’ off shore version of the Chinese currency, has seen volumes sky rocket year on year. With the opening of more off-shore centres such as the Shanghai Freetrade Zone trading in the currency is increasing all the time. If investors are looking outside of the G10 the US Dollar/Chinese Yuan Renminbi (USD/CNH) is the pair that they tend to look at. ‘
While these sort of currencies do still see respectable volumes there are some differences we should be aware of when looking outside the usual forex suspects. Angus Campbell, senior analyst at FXPro explains.
‘Here it’s all about liquidity - it may look attractive to trade a lesser known currency pair, but due to its illiquidity, the lack of trading activity and volume, it might suffer from very wide spreads. Clearly this means the cost of doing business in more exotic currencies can be more expensive. In addition this can lead to a market gapping on news resulting in “slippage” - where your order to buy or sell gets filled at a worse price than you were expecting.’
Steve Ruffley, chief market strategist at Intertrader expands on this. ‘When trading “less obvious” pairs the main difficulty is directional volatility. When something like the EUR/USD there will usually be significant interest in every price, making trading “orderly”. With less popular pairs this doesn’t happen. Once the direction is set, very often the market trends and this can mean very little retracement against that trend in the short term. This means it can be very difficult to set an accurate risk reward when trading some of these exotics. The plus side of course is that riding onside trades is relatively easy as there are so few pull backs.’
It’s all well and good of course deciding to trade some of these somewhat obscure currency pairs – but we need information to help us make a decision. Just how hard is this to come by? Back to our experts once again, Michael van Dulken at Accendo Markets says it does not have to be hard to come by if you focus on the ‘right’ currencies.
‘What’s been nice in terms of the less popular/exotics recently, however, has been the wide media coverage of the Russian situation. This has allowed retail investors, who can now so easily trade what they like, when they like and wherever, to get more involved in trading the likes of US Dollar/Russian Rouble. There has been so much media coverage – both on financial and mainstream news channels. It has helped traders appreciate the implications of President Putin’s stand-off with the West and how such geopolitical developments can offer profitable trading opportunities.’
Steve Ruffley of Intertrader goes one step further and argues in-depth news on these currencies may not be so important. ‘The exotics are never really that exotic these days. With so much information out there even a novice trader can access charts and information regarding exotic pairs. My rule of trading is that markets move 20% of the time fundamentally and 80% technically.’
Looking for ideas
To help us narrow down just what should we be looking at, our experts have flagged up some potential opportunities. First of all, Michael Hewson, chief market analyst at CMC Markets.
‘For the past twelve months the Australian dollar (AUD) has performed the best against the US dollar largely due to the cost of carrying a short position on the currency for any length of time, making it very expensive for traders to sell-short the Aussie.
‘Australian interest rates are at 2.5% while US rates are around zero which means any short position has a negative carry and as such means that it costs the trader money to run the position. You therefore need to be fairly certain that any long term gains outweigh your holding costs.
‘One way to mitigate these costs would be to trade the forward contract on Australian Dollar/US Dollar (AUD/USD) where the spread is wider on entry, but there are no holding costs involved, when rolling the position day to day. To be worth your while though you would need to run the position for more than a week to offset the wider spread.’
Brenda Kelly of IG suggests looking east for an opportunity. “If as a trader you believe that the ‘trend is your friend’ then it’s impossible to overlook the US Dollar/Russian Rouble moves over the past year.
‘Since mid-July, the rouble has shed over 20% of its value against the dollar. The Russian Central bank may well decide to raise interest rates for the fourth time this year in an effort to stem the flight of assets and attract new investment. This could put a ceiling on the current trend and could also help relieve the high levels of inflation in Russia.’
And Angus Campbell at FXPro suggests a change in US monetary policy could well be the driver next year ‘Emerging market currencies are likely to become exciting in 2015 as we near the Federal Reserve’s first rate hike. The dollar in particular could continue to make gains against the likes of the Brazilian Real (BRL).’
Consider the risks
It really is a world of opportunity out there when it comes to trading foreign exchange whether you prefer the major pairs or some of their more exotic cousins. It is important to understand that, as with any market that sees relatively low volume compared to its peers, trading some of these currencies will be more expensive. The bid/offer spread will be wider due to the relative lack of underlying liquidity in the market – in the same way a small-cap share will not have as tight a spread as the BP (BP.) share price for example.
Also, geo-political developments can sometime result in sharp moves in exotic currencies – if you are the wrong side of this you could end up losing more than you planned. But as long as these risks are understood, there is no reason why trading the less well-trodden path cannot be an option for some.