Wider spreads, more volatility

Forex traders should not jump into the world of the exotics without a great deal of research and understanding of the risks associated with these currencies. Some strategists caution that only the most seasoned retail players should enter this arena because of the higher volatility, lower liquidity, and wider spreads these currencies tend to display.

“The spreads on exotics can be fairly wide because these markets are less liquid,” says GFT’s Jamgotch. “Retail traders need to keep in mind there is limited liquidity in many exotic pairs, which means spreads tend to widen when these local financial markets are not open.

“The typical GFT spread for the USD/ZAR (U.S. dollar/South African rand pair) is 150 pips, and during some market conditions, such as when the South African market is closed, it is not uncommon for the spread to widen to more than 500 pips.

” FXCM’s Lee says volatility and liquidity are bigger concerns than people think when trading emerging markets because retail traders are not used to violent fluctuations.

”Unless retail investors trade crosses such as the pound/yen, they are more [accustomed to] 30-pip daily fluctuations,” he says. “The rand moves almost 10 times that in single session. However, you always have to take into account the pip cost, which essentially puts things back into perspective.”

A pip in the ZAR currently is worth about $1.45 vs., say, roughly $10 for a pip in the euro/dollar pair.

“Another factor retail traders should be aware of is the volatility in exotic currencies around fundamental news releases can be much higher than in major currencies,” says GFT’s Jamgotch. “This means market gaps and slippage are more common.”