There is a large number of forex pairs traded in small volumes, and some traders prefer them over the so-called "majors." Learn about the pitfalls of "thinly traded" currency pairs from this article.
Low Liquidity
Liquidity in forex stands for the amount of money flowing through the market at a particular point in time. High liquidity means it is easy to sell or buy a trading instrument quickly at an existing price. The higher the trading volume of a particular instrument is, the more liquid the instrument is. Although the forex market volume is the highest among all markets, not all currency pairs can be considered equally liquid. Major currency pairs can boast high liquidity, unlike minors, let alone exotic pairs.
An example of such exotic currency pairs is USD/HKD. This currency pair is hard to buy or sell in large sizes due to its low trading volume and the number of market participants. From the chart below, one can notice that buying or selling volume at any moment can vary greatly, creating gaps between candlesticks.
The reason why most traders prefer majors (the most liquid pairs) is because the risk of trading an illiquid asset is too high if the market moves against your prediction. Low liquidity, in its turn, can lead to another problem known as slippage.
Read more: Forex Trading for Beginners in 2022
Slippage
Look at the price gaps on the chart again and consider how instantly they occur. In the situation when the price changes so abruptly, a trader can open an order at one price but have it executed at a completely different price. And the change doesn't always play into the trader's hand. The reason is again low liquidity, as it takes more time to find buyers for your sell deals or sellers for your buy deals – there are simply not enough players in the market. The difference in the price from the time of placing an order until its execution is called slippage.
Profit Taking
Low liquidity means few market participants interested in the asset. So it might be hard to buy/sell a low-traded currency quickly. Suppose you buy a certain amount of illiquid currency pair. Once you realize the price is at a good place to go short, you try selling it but have difficulty doing it since there is no one to buy it at that time. The result is a lost opportunity.
High Spreads
Liquidity directly affects spreads (the ask/big price difference), which is particularly important for retail traders. It is low demand and consequently low trading volume that make currency pairs of developing countries have larger spreads. Thus, mind that trading low-volume forex is accompanied by higher transaction costs, and it is important to calculate the profit loss ratio taking into account these costs.
Why Trade Low-Volume Currency Pairs
The most valid reason why thinly traded currencies occasionally attract a trader’s eye is news trading opportunities. Suppose an important economic data release(e.g., interest rate) is expected in the country. Some traders gladly speculate on those kinds of events and sometimes even make impressive results. Besides that, trading low-volume currency pairs is simply not worth the risk.
Read more: What are the Best Forex Currency Pairs to Trade
How to Trade Low-Volume Currency Pairs
The first question that may come up is which forex pairs are better to trade. If you decide to trade exotics, it is reasonable to pick a pair with one major currency in it. If you decide that trading low-volume pairs is worth the risk, here are a few pairs to consider:
- JPY/NOK (Japanese yen/Norwegian krone);
- USD/THB (US dollar/Thailand baht);
- EUR/TRY (Euro/Turkish lira);
- AUD/MXN (Australian dollar/Mexican peso);
- USD/VND (US dollar/Vietnamese dong);
- GBP/ZAR (Sterling/South African rand).
Also, don’t rush to put a lot of money into such a risky asset. For novice traders, it is best to start with a single currency pair and observe its behavior over time. Test a few strategies to check what might work, maybe even do it on a demo account. Pay special attention to news trading – this is where traders tend to find occasional success.
Final Words
Having considered all the risks of trading low-volume currency pairs, we conclude that it is most likely a bad idea. If you are new to trading, starting with exotics is unreasonable – it is simply a bad way to learn. Instead, going for majors is a more sound decision as bad trades (which occasionally happen even in professional trading) are unlikely to lead to such big financial losses as when trading thinly traded currencies.
If you decide to trade low-volume currency pairs anyway, we have advice for you. Do not try trading multiple instruments at a time. Pick one currency pair and take time to study its behavior. Test one strategy or another until you realize what works best. If your efforts don't pay off, reconsider trading major currency pairs. Sometimes it is worth taking the easy road.
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FAQ
Why is Forex a Bad Idea?
Forex might be a bad idea for people who take currency trading as gambling and hope to get rich overnight. On the opposite side, it can be a profitable business for those who are interested in financial markets and ready to allocate some time to learning.
Is Forex Trading a High-Risk Activity?
Forex, like any other financial market, involves risks. To avoid those risks, one needs to master the art of risk-reward management.
What are the Disadvantages of Forex Trading?
The main risk of forex trading is associated with high leverage trades. Leverage is the funds borrowed from a third party to increase the possible earnings. Forex offers the largest leverage.
Can you Lose all your Money in Forex?
Irresponsible trading based on guessing rather than on grounded decisions may lead to the loss of funds.
Can Forex Make you Rich?
Forex can make you rich if you take it seriously and allocate time and effort to this business. Experienced traders have proved to make 5-15% profit from what they invest.
How Difficult is Forex?
Financial markets, including forex, can indeed be difficult, especially for people with little financial education. However, those ready to spend time on learning are likely to master it quickly.
How Much do Forex Traders Make a Day?
The profits of traders correlate with their experience, skills, and the size of capital they trade on. Experienced traders can make as much as 5-15% of the funds they trade with.
by , 2021.08.25