MINOR CURRENCY PAIRS EXPLAINED: LIQUIDITY AND VOLATILITY

In the foreign exchange (forex) market, currencies are traded in pairs. These pairs are typically classified into three major categories: major pairs, minor pairs, and exotic pairs. While major pairs involve the world’s most traded currencies and always include the US dollar (USD), minor pairs — also known as cross currency pairs — are composed of major global currencies excluding the USD.

Minor currency pairs often include pairs such as:

• EUR/GBP (Euro / British Pound)
• EUR/JPY (Euro / Japanese Yen)
• GBP/JPY (British Pound / Japanese Yen)
• CHF/JPY (Swiss Franc / Japanese Yen)
• EUR/AUD (Euro / Australian Dollar)

Each of these pairs involves two strong, developed-market currencies but no US dollar. This lack of USD inclusion leads to certain unique characteristics in terms of how these pairs behave in the market — particularly in aspects such as liquidity and volatility.

The reason for trading or analysing minor pairs often lies in diversification. Traders may look to minor pairs to find opportunities unaffected by USD fluctuations, which can dominate the behaviour of major pairs. At the same time, the dynamics of supply and demand in minor pairs are driven by geopolitical and economic factors that may differ from the more globally focused influences on major currency pairs.

To fully comprehend the dynamics of minor pairs, it's crucial to delve into how they differ from both major and exotic currency pairs, particularly in the areas of liquidity and volatility. These factors not only affect the execution of trades but also play a key role in determining risk levels and overall trading strategy.

Liquidity refers to the ease with which a financial instrument can be bought or sold in the market without significantly affecting its price. In the context of forex trading, greater liquidity means tighter spreads, faster execution, and typically, lower risk of slippage. Major pairs such as EUR/USD or USD/JPY enjoy the highest liquidity globally, largely due to high volume and trader participation. Minor pairs, however, typically display lower liquidity, which comes with its own set of implications.

Here is how the liquidity landscape typically changes with minor currency pairs:

• Lower Trading Volume: As minor pairs exclude the US dollar — the world’s most traded currency — the demand and trading volume are naturally lower. This lower activity means that fewer traders are available on either side of the trade.
• Wider Spreads: Because market makers take on more risk due to lower liquidity, they typically charge wider bid-ask spreads. This means that entering and exiting trades in minor pairs can be more expensive than with major pairs.
• Variable Execution Speed: With lower liquidity, execution can become slightly less predictable, particularly during off-market hours or during volatile economic releases in either of the two involved countries.

Despite these considerations, minor pairs still offer a relatively liquid market compared to exotic pairs, which often involve emerging market currencies. For example, a pair like EUR/JPY, while less liquid than EUR/USD, remains actively traded and supported by many forex brokers with decent execution capabilities.

Institutional Traders and Liquidity: It's also worth noting that institutional investors often allocate capital to minor pairs for hedging or arbitrage purposes when macroeconomic conditions change. Their participation can increase liquidity during certain windows, especially during the overlapping of major market sessions — such as the London and Tokyo overlap when trading EUR/JPY or GBP/JPY.

Liquidity risk becomes an important concept to understand in minor currency trading. During global events or holidays when one of the base currencies’ markets is closed, liquidity in these pairs can drop sharply, creating higher risks for intraday traders and scalpers.

Traders dealing with minor pairs must therefore consider time zones, news releases, central bank interventions, and cross-border economic policies more carefully than with major pairs. Selecting optimal trading hours and understanding the pricing of spreads could enhance transaction success and minimise exposure to unexpected costs.

Volatility measures how much the price of a currency pair fluctuates over a given period. While liquidity and volatility are interconnected, they are not synonymous. In many cases, minor currency pairs exhibit higher volatility than major pairs — a trait that traders either seek or guard against based on their strategies.

Several factors account for the increased volatility typically observed in minor currency pairs:

• Lower Liquidity: As mentioned, thinner markets can exaggerate price moves, particularly when economic news breaks or there’s geopolitical uncertainty. The lack of USD also means price discovery can be less stable due to lower aggregate volume.
• Divergent Economic Cycles: Unlike major pairs, which are often aligned through global policy or economic cycles (e.g., USD and EUR are both influenced by global sentiment), minor pairs often involve countries at different stages of economic development or interest rate cycles. For example, EUR/AUD might swing significantly due to changes in commodity prices affecting the Australian dollar.
• Central Bank Policies: Central bank decisions in more trade-exposed economies like Switzerland, Australia, or Japan can move their currencies rapidly, especially against other majors. When neither currency in a pair anchors in USD, pricing can reflect more regionalised movements, thus creating sharper swings.

Examples of relatively volatile minor pairs include:

• GBP/JPY: Known for its wide daily ranges and strong trending periods, this pair is popular among experienced traders for its movement potential.
• EUR/NZD: With both currencies influenced by different hemispheric conditions — the Eurozone vs. Oceania — this pair can present erratic movements when news from either region breaks.
• CHF/JPY: Market sentiments on safe havens can quickly unlock significant price moves in this cross-pair involving two traditionally defensive currencies.

While volatility is sometimes seen as a source of risk, many experienced traders seek it to generate profits quickly. However, it also increases the probability of slippage, margin calls, and wider stop-outs — critical elements to account for in risk management.

Using Volatility to Strategise: One way to approach the volatility of minor pairs is through shorter trading durations or using event-driven strategies that revolve around macro announcements. Moreover, using tools such as average true range (ATR), Bollinger Bands, and volatility indexes can help traders better measure and adapt to volatility levels in their preferred minor pairs.

Bottom Line: Minor currency pairs are not just less prominent versions of majors — they offer unique conditions that demand careful planning. Their increased volatility may be seen as either an opportunity or a risk, depending on the trader’s style. Careful timing, position sizing, and stop-loss discipline become paramount when operating in this segment of the forex market.