This is how CFD trading with exotic currencies works

CFDs can also be used to bet on emerging market currencies. In doing so, however, investors have to pay attention to special features.

The majority of trading turnover in currencies is made up of the world’s most important currencies. These are US dollars, euros, yen and francs. However, emerging market values ​​are also playing an increasing role. Their share of OTC foreign exchange turnover has more than doubled from twelve percent in 2007 to 25 percent today.

The main reason for this is that China and India, but also South Korea and Brazil, are playing an increasingly important role in the global economy. In addition, these countries are increasingly issuing bonds in local currencies. This has increased the need for investors to hedge their currency exposure accordingly.

Not only professional investors can get involved in currency trading, but also private investors. You can bet on the most important currencies with derivatives or ETCs. But there are some not insignificant currencies for which there are no products. These include Brazil’s real and South Korea’s won. Nevertheless, investors who want to speculate on it do not have to do without – because with CFDs this is possible with a few providers.
Note the lever

However, investors should note the special features of these products. CFDs are leverage investments that enable high profits, but can also cause large losses. A leverage of five means, for example, that the value of a long CFD increases by five percent if the preferred currency climbs by one percent to the other currency. The lever also works the other way round. If the speculation does not work out, high losses will result. Therefore, private investors should only choose low leverage.

This applies all the more to less common currencies such as the real and won, which are far more volatile than the world’s leading currencies. “In addition, due to low liquidity and sometimes high fluctuations in emerging market currencies, the spread is significantly higher than, for example, for EUR / USD. In turbulent market phases, the bid-ask spreads widen”, says Konstantin Oldenburger, market analyst at CFD- Broker CMC Markets, to consider.

Especially since there is no official trade surveillance. Legally speaking, CFDs are an agreement between investors and brokers. The latter sets the courses, sets the conditions, and offers appropriate trading opportunities via its online platform. The higher spread should not be neglected for investors. Alternatively, to avoid high spreads, you can also trade currencies with other financial derivatives such as binary options instead of CFDs. “These are nothing more than higher costs with CFDs, as traders first have to earn the spread in order to get into the profit zone,” says Dirk Friczewsky, a market expert at CFD provider ActivTrades.

Take interest into account

If investors hold the positions overnight or for a longer period of time, the interest rates of the currency pairs also play an important role if interest rate differentials exist. While the key rate is currently 5.25 percent for the real and 0.75 percent for the won, it is zero for the US dollar. Depending on whether investors are now speculating on a rising or falling real or won against the dollar, they will receive an interest refund or interest will be charged to them. “Due to the high interest rate differentials to the world’s leading currencies, the debits or credits are significantly higher than with major currency pairs. This can then bring the investor either an additional profit or a loss,” says Oldenburger.

Friczewsky therefore recommends: “Especially with exotic currencies such as won and real, investors should inform themselves about the interest rate differentials before buying. Interest rate hike discussions such as the recent one at South Korea’s central bank should be observed. An assessment of the current monetary policy can also be viewed on the websites of the central banks”, so the expert.

But he and Oldenburg investors can take one worry away. “In principle, the emerging market currencies can also be traded around the clock, so that the overnight risk can be viewed as minimal,” the two experts agree.
This also applies to the Korean won. Investors can trade it with the CFD brokers IG and Lynx. But only against the US dollar, not in combination with the euro. The strong international demand for computer chips and other electronics has given South Korea a strong boost. The economy is expected to grow by around four percent in 2021. The country got through the first and second waves of COVID well. Therefore, the won rose against the dollar for a long time. But for a few months he has been weak.

There are several reasons for this. So the pandemic has returned worse than before. Although there is no lockdown, public life has been restricted. In addition, inflation climbed to 2.6 percent in August, higher than expected. Above all, however, household debt has risen sharply. Therefore, the central bank raised the interest rate from 0.25 to 0.75 percent at the end of August. “It is not as if the economy is going under in the latest virus wave, but the central bank could no longer ignore the indebtedness of private households,” says Gerhard Heinrich, emerging market professional at the information service Emerging Markets Trader.

This mix of negative factors has seen the won weaken against the dollar in recent months. This trend should continue for the time being. In terms of charts, the currency pair is also facing important resistance at 1,175 and 1,208 won per dollar. If these are exceeded, the way to the top is free.
For the real, on the other hand, from a technical and fundamental point of view, it looks like higher exchange rates against the dollar. This currency pair is tradable with the brokers IG, ActivTrades and Admirals, but there is no offer for the euro. The country is struggling with political turmoil as several investigations are pending against President Jair Bolsonaro. His re-election next year is uncertain. But the pandemic, which raged violently on the Sugar Loaf, has been contained by vaccinations. The incidence value is now 49. Financial institutions currently expect growth of 5.2 percent for 2021.

The problem is the high inflation, which is 9.7 percent year-on-year. The central bank is trying to counteract this with a rate hike from 4.25 to 5.25 percent. “The real strength against the dollar is also due to the fact that Brazil’s central bankers, unlike their colleagues in other countries, are bracing themselves against inflation,” Heinrich praised the monetary authorities at the Sugar Loaf.