From the April 01, 2012 issue of Futures Magazine • Subscribe!

How to begin trading exotic currencies

With more than $4 trillion in daily liquidity, the currency markets are the largest markets available to traders. With liquidity that size, opportunity can exist in unexpected places. Although G-10 currencies such as the U.S. dollar, euro and yen dominate much of the trading action, smaller, more exotic currencies can offer further prospects, if you are looking and understand the unique challenges they present.

George Fischer, director of product management at E*Trade, says a whole other world exists outside of the majors. “There are the majors, and there there’s everything else. Within the everything else, you have some pretty established countries of the world, such as Sweden, Norway and Hong Kong. Emerging markets are a subset of exotics,” he says. “First and foremost, exotics are about opportunity.”

That opportunity can come in a variety of ways, from a possible interest rate and carry trade position, to making a play on the commodity markets through a related currency. But, like everything, that opportunity often has a cost, and understanding the unique difficulties of smaller currencies is key to success. A grasp of the market structure goes a long way in alleviating those difficulties.

Like any currency trade, exotic currencies always are traded in pairs. For U.S. traders, it can be easy to assume the U.S. dollar will be the currency base the exotic is traded against, but the base can be any number of other currencies, making it a cross pair. As such, fundamental forex traders have to do double duty researching interest rates and conditions of both countries represented in the pair. “With economics and news becoming a little less pervasive about the currency market in some area, it’s about taking your research to the next level and developing a good fundamental understanding of the two currencies, and how the interactions work between them,” Fischer says.

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