The old adage advises us never to put all our eggs in one basket. This is sound advice, especially for investors, as investing all your capital in one vehicle can prove detrimental when the said vehicle goes south. For that reason, it is always advisable to dip your fingers in several pots, in what is referred to as diversifying your portfolio. For forex traders, this may look like investing in different types of currency pairs, all in a bid to take advantage of the best of all worlds.
Types of currency pairs
Currencies are traded in pairs on the FX market. That means by buying a pair, you’re simultaneously buying one currency and selling the other. To that end, pairs are classified into:
- Major pairs – These involve a pairing of the currencies of the world’s largest economies, one of which must be the USD. They are the most popular pairs among traders, as they enjoy high liquidity and predictability.
- Minor pairs – These pairs do not include the USD but will feature the other world’s major currencies, such as the EURGBP and AUDNZD. They have lower liquidity than majors, and finding financial data on them is a little more difficult than majors.
- Exotic pairs – These involve a major global currency paired with a currency from an emerging economy such as the TRY (Turkish lira) or ZAR (South African rand).
Points to note about exotic currency pairs
Whenever you’re trading an exotic pair, there are three things you should always keep in mind. First, due to their low popularity, not all brokers will provide these pairs for trading. Therefore, you need to take this into consideration before choosing your broker.
Second, finding financial information on these exotic pairs is often difficult. There is abundant data on large economies like the US and the Eurozone, but regions like Turkey and Hungary may have far less data available online.
Further, the lower liquidity characteristic of these pairs may introduce slippage costs. Slippage means your order is executed at a different price than that quoted at the time of order placement. This is because such orders often take longer to fulfill.
That being said, let’s take a look at the best FX portfolio to employ in 2022.
Best forex portfolio in 2022
This is the most traded pair in the FX market. It represents the main currency used in 19 of the 28 member countries of the EU, paired with that of the US. The USD is the world’s unofficial reserve currency, and most international transactions, as well as debts, are settled using the greenback. The pair enjoys high liquidity and competitively low spreads.
This pair’s price is mainly affected by monetary policy and interest rate decisions from both the US Fed and the European Central Bank (ECB). Whichever bank sets the lower interest rate causes their currency to decline against the other. Other economic factors to look out for include employment figures, GDP, and CPI from both regions.
This is another highly liquid pair, mainly because of the dominance of the dollar in world economics, while the Japanese yen dominates trade in the Asian region. The Japanese government maintains tight control over the value of their currency so as to control the value of their exports, using what is called a dirty float system. The JPY is also a common reserve currency, as is the USD, euro, and GBP.
The factors behind the price moves for this pair are monetary policy decisions from the Fed and the Bank of Japan. The occurrence of natural disasters such as earthquakes in Japan also plays a part in the value fluctuation of the JPY.
This pair represents Great Britain’s pound and the US dollar. Its value is mainly dependent on the state of the two economies, which can be extrapolated from employment data, CPI, and GDP report. Its price is also heavily dependent on interest rate decisions from the Fed and the Bank of England.
Historically, the GBP’s price has been majorly influenced by the great recession of 2008 and the 2016 vote to exit the EU, commonly referred to as Brexit. Both of these events significantly devalued the GBP in the last decade.
This is an exotic pairing of the greenback and the South African rand. It is popular among traders because of the trade relations between the two countries. The South African economy has historically been inferior to that of the US, thus creating a bullish bias for the pair. However, there are instances when the ZAR outperforms the USD, creating opportunities for short trades.
Further, the South African Reserve Bank has set its interest rate at 3.5%, while that of the US is currently at 0.25%. This interest rate differential attracts many traders interested in the carry trade.
This pairing involves the dollar and the Turkish lira. The pair has exhibited one of the most consistent bull runs in the FX market. In 2021, the USD rallied more than 42% against the TRY. This can be attributed to the ongoing economic instability in Turkey following its rising inflation, debt crisis, and political instability. All of this has seen the lira gradually devalue, thus presenting opportunities for long trades.
Major pairs tend to enjoy high liquidity and lower spreads, but they are usually more competitive markets. Exotic pairs, on the other hand, are much harder to trade, but their high volatility characteristic presents experienced traders with more potential for profit. However, they also have drawbacks such as large spreads and slippage costs and a lack of predictability owing to the shortage of economic data on them.
To maximize profits, a trader should consider a healthy mix of major and exotic pairs in their portfolio. With the proper risk management and trading strategies, such a mix can be the key to a successful forex trading career.