Trading in exotic currencies

"Risk comes from not knowing what you're doing", was the famous line of renowned forex trader Warren Buffet. In the world of foreign exchange, investing in stable economies can be our comfort zone. But there are also high risk/high yield currencies consisting of investments in emerging market economies such as Thailand, Mexico, Brazil, Russia, and Turkey. Investing in emerging markets, or exotic currency trading can yield a lot of benefits from those who know what they are doing. For novice traders though, 'Better safe than sorry' is the motto of the day.

But the learning curve has to start from somewhere doesn't it? So how do we take the first step?

In an article written by Peter Rosensteich, he mentioned that certain fundamental factors must be considered in analyzing emerging market economies. Indeed, he mentioned that fundamental factors were more important than technical considerations. So these are the basics we have to work on even before we begin to think of trading in exotic currencies.

So what are these fundamental risks to consider? Some of the most important aspects include: economic development, political stability, and transparency.

Economic development. Granted, we all know that economic development plays a major role in affecting the currency's value. But some difficulty in analysis is involved due to the nature of emerging markets. There are some indicators that might be misleading. A very good example is the Gross domestic product or the GDP.

Unlike developed economies which are generally strong as a whole, it is quite possible for a developing economy to be based or powered by a single industry. Thus, while the GDP may show a good and strong economy, the conditions may change unexpectedly in that single industry or sector, and the whole economy could go down with it. This makes the GDP a very unreliable indicator for emerging market economies.

Political stability.

Political stability is a very important factor to consider too. It is after all, the government that sets the policies that affect the trend and direction of an economy. A stable political environment means a higher consistency with regard to economic policies and therefore would result to a stronger and more stable currency. Whereas a government that is in the midst of political strife could mean inconsistency that could result to a weaker currency value.

Transparency.

In emerging markets, lack of transparency exists not just in regard to the country's economic activities but also in all of its other aspects. This may be inadvertent - caused by economic barriers in data collection. Or intentional - propelled by an intensive effort to hide facts, as in the case of China. But the result is the same. But whether we're talking about economic development, political stability, or transparency, these economic indicators ultimately address one pivotal issue; that of reliability.

These indicators give us an estimate of how reliable the currency is, so that we can put our money in it. After all, risk only comes from not knowing what you're doing.