The forex market is the place where the buying and selling of international currencies take place. Just like how stocks work, forex trading’s end goal is to produce net profits through buying low and selling high.
The forex market gives you the opportunity to leverage a certain amount of money. This can end up producing incredible profits or sustain devastating losses.
You as the forex trader also have the advantage of choosing a handful of currencies. This is better compared to stock traders who must examine thousands of companies and sectors before being able to choose.
But now, let’s learn about the forex trading risks that accompanies your involvement in the largest trading market in the world.
1. Broker Risk
Before you hand over your capital, you must make sure that you’ve done your research and found a reputable broker. Having a risky broker can hugely affect both you and your working capital in different ways. Not all brokers and regulated, and let’s face it, not all of them will put your best interest first.
Having un-regulated brokers might be tempting to some brokers due to possibly lower operating costs. Obtaining and maintaining a regulatory license can prove to be too expensive. Also, there are capital requirements set by regulatory bodies that limit entry for a lot of brokers. Especially if those said brokers are unable to raise and present the necessary capital.
It is mostly recommended to try to work with a regulated forex broker.
So before deciding on putting your investment capital and trust on that broker, you need to first make sure that the broker – individual or company – is someone you can truly rely on.
2. Credit Risk
This risk takes place when one party to a trade is unable to pay the other. You usually expect that the person or institution on the other side of the trade is capable of paying if the trade ends up going your way. But the credit risk exists for a reason, and that’s for when one party defaults or becomes bankrupt.
The goal of credit risk management is to try to lessen these risks by properly exposing the credit risk. You should always be aware of the rules and regulations that the other party in a trade abides to. This will let you anticipate and learn of what
3. Devaluation Risk
This happens when a country intentionally lowers its currency relative to another country’s currency. Devaluation is a monetary policy tool used by countries that have fixed exchange rates. This is the direct result of government activity. One of the reasons that this occurs is to avoid imbalances in trade. Whenever a currency is devalued, the value of country’s exports lessens. This then makes the exports less expensive and more competitive on the open global market.
4. Exchange Rate Risk
This is the risk exposure shown through the active changes in a currency’s value. Exchange rate risks are mostly present in companies that operate in multiple countries or those that exports their products regularly.
5. Interest Rate Risk
Interest rates tend to fluctuate most of the time. It’s important to remember that an entity or institution borrows funds from a certain lender. A given interest rate will be asked in exchange for the funds that the lender will provide.
The interest rates charged are usually determined through the amount of risk the lender takes.
You should keep in mind that a country’s interest rates and currency exchange rates are often linked together. You can receive great returns if you would be patient enough to monitor interest rate changes to find information regarding where the biggest institutions will be investing their assets.
It’s also important to note that currency pairs with higher yielding interest rates gather the most attention.
6. Margin Risk
Also known as leverage risk, this might end up playing an important role in forex trading. Margin trading give you the opportunity to utilize leverage.
Normally, you only have to put up a percentage of the total value of position when you begin trading forex. It can then be considered leverages if you’re able to improve your position size through the use of borrowed capital. The amount required to be place upfront is known as the margin requirement. There are several brokers that may allow you to leverage up to 100:1.
But it’s not immediately a good idea to use it despite the high leverage offer.
7. Operational Risk
This happens when internal processes, systems, and people get involved. In addition to this, operational risk may consist of fraud, legal risks, and security. Operational risk and management goes hand in hand. For instance, having a strong management team will lessen the degree of operational risk and vice versa.
It’s not easy to determine the degree of operational risk that you get to expose yourself in. however, being a trader, you are responsible to make an effort of reducing your operational risk as much as possible. You can start with due diligence. Do your research and evaluate the way a business operates.
8. Political Risk
The forex market is heavily influenced by the political and economic problems that can put their respective currencies at risk. There are elections that take place constantly throughout the world. Such events can then lead to huge alterations in the country’s investment landscape, creating forex trading risks
It’s imperative that you keep an eye on any economic changes that can take place on the country with or without any notice. This is to prevent any unpleasant surprise that can happen, such as extreme volatility in country’s exchange rate.
Thankfully, there is something that can help you manage these unpleasant surprises, an economic calendar. This will give you the when and what of an event that is set to take place in the near future so that you can better prepare. Important new events are added to an economic calendar as soon as they are announced.
You should always stay ahead when it comes to current events and daily news, planning and strategizing your trades.
9. Volatility Risk
You should always have the matter of volatility in your mind whenever you consider starting any trade or investment. Volatility risk pertains to the degree of fluctuations that can occur within the forex market.
Volatility may seem negative to most forex traders but it also has positive components. A certain degree of volatility can help you benefit in your trading activities. Volatility usually spikes and become incredibly high when high impact news events happen. Be careful of such times since they can affect your trading position in a bad way.
Read more on how to avoid losing money in forex trading.
It’s important for you to learn how to implement forex risk management.
Before you consider yourself a trader, you should first learn how to be a risk manager. You must be responsible in managing your money and the risk level that can be found in your portfolio.
Always keep in mind that you should never risk more than you can afford to lose. Do not take too much advantage of loose leverage given to you by your broker. You could end up regretting it after the long run, when it’ll be hard for you to retreat and regroup.
Forex trading risks can affect you differently. It can help you sometimes (volatility risk), but hurt you with false hope (margin risk). So you should never neglect to exercise due diligence. Be a well-informed trader in the largest trading market in the world.