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The foreign exchange market, also known as the forex market, facilitates the buying and selling of currencies around the world. Like stocks, the end goal of forex trading is to yield a net profit by buying low and selling high. Forex traders have the advantage of choosing a handful of currencies over stock traders who must parse thousands of companies and sectors. In terms of trading volume, forex markets are the largest in the world. Due to high trading volume, forex assets are classified as highly liquid assets. The majority of foreign exchange trades consist of spot transactions, forwards, foreign exchange swaps, currency swaps and options. However as a leveraged product there is plenty of risk associated with forex trades that can result in substantial losses.
Forex Risk Management
As a forex trader, you are first and foremost a Risk Manager, responsible for managing your money and the level of risk within your portfolio. One of the fundamental rules in forex risk management is that you should not risk more than you can afford to lose. One of the biggest mistakes forex traders make on a consistent basis is the aggressive use of leverage; some often utilizing the maximum amount which their forex broker offers. This is clearly a recipe for disaster which will be realized sooner than later by overly aggressive traders.
In addition, controlling one’s emotions plays an important role in your overall risk management plan. If you are unable to control your emotions, you will make critical mistakes in your trade execution. When markets become volatile you need to control your emotions and respond objectively and with a cool head.
Becoming an informed trader with risk management in mind is not impossible but does take a good deal of discipline. You should have a structured well thought out plan which includes the various components of risk and how you intend to address each. Now’s lets take a closer look at some of the risks that forex traders need to pay careful attention to.
Margin Risk
Margin or leverage risk can play a significant role in forex trading. What exactly is margin trading? Margin trading allows you to utilize leverage. Usually, when you are placing a forex trade, it is necessary for you to put up only a portion of the total value of the position as good faith. Your trade is considered leveraged if you are able to enhance your position size with borrowed capital. The amount which is required to be placed upfront is deemed as the margin requirement. Many forex brokers allow their forex trading clients to leverage up to 100:1. But just because they allow such high leverage, doesn’t necessarily mean that is it a good idea for you to use it.
Political Risk
Political and economic risk can play a significant role in how you trade within the spot forex market. Elections are taking place constantly throughout the world. Economic and political factors can alter the investment landscape within a specific country, which can generate risk for forex traders.
During elections there can be moments of political instability and uncertainty within a country, which usually leads to greater volatility in the country’s exchange rate. As a rule of thumb, you should keep a close eye on pre-election polling so that you will not be surprised with the voting results.
When a change in government takes place within a country the ideology of the residents of the country may also change due to the new political environment. Changes in political parties can shift the new government’s approach to monetary and fiscal policy.
When unexpected elections take place within a country, additional uncertainties can arise. Unexpected elections can arise from various instances such as a vote of non-confidence, corruption or scandals. Usually, unplanned elections can be very problematic and increase the volatility of a country’s currency. In addition, unexpected elections can trigger other events such as protests or labor strikes. It is extremely difficult for you to anticipate these events, however the more cognizant you are regarding the political affairs within a country, the easier it will be for you to react to sudden changes.
Making use of an economic calendar will allow you to track when important scheduled news events are going to take place so that you can better plan and strategize your trades. In addition, most forex brokers offer their trading partners live streaming news. You should be monitoring current events and news which may impact your trading positions.
Learn What Works and What Doesn’t In the Forex Markets….Join My Free Newsletter Packed with Actionable Tips and Strategies To Get Your Trading Profitable…..Click Here to Join
Interest Rate Risk
Another major component of Forex risk is interest rate fluctuations. We know that when an entity or institution borrows funds from a given lender, the lender will provide those funds in exchange for a given interest rate on the loan.
The rate of interest charged will typically be determined by the amount of risk the lender takes. Usually, borrowers who are considered high risk will pay a higher interest rate on a loan. Conversely, borrowers who have a lower risk profile will invariably pay lower interest rates over the life of the loan.
Central Banks are responsible for setting monetary policies within their counties to ensure economic growth and stability. These fluctuating interest rates in the foreign exchange markets drive numerous decisions for traders.
It is important to note that a country’s interest rates and currency exchange rates are often linked hand and hand. By carefully monitoring interest rate changes, you will know where big institutions are investing their assets in order to receive the greatest return possible.
Many times big institutions focus on the carry trade, which is an interest rate differential based trade. Generally, the higher yielding interest rate currency pairs attract greater demand.
Exchange Rate Risk
Exchange rate risk in its simplest context is the risk exposure posed by the dynamic changes in the value of currency. Exchange Rate risk is of particular importance to companies that have operations in multiple countries or that regularly export their products.
Volatility Risk
Volatility plays a significant role in accessing foreign exchange risk. Volatility risk describes the degree of fluctuations within the markets and should certainly be included in a trader’s thought process.
When you are trading you should be aware of the rules and regulations that the forex broker abides by. It is of the utmost importance that a forex broker is regulated appropriately in the country that they do business in and maintain the proper reserves in case the other party associated to the trade cannot cover their trading loses.
As a forex trader it is not always easy to determine the amount of operational risk that you are exposed to, however, as a trader it is your responsibility to research and evaluate a business’s operation in an effort to reduce operational risk as much as possible.
Broker Risk
Prior to handing over your capital, you want to make sure you do your homework and find a reputable forex broker. Broker risk, can impact you and your working capital in numerous ways. Some forex brokers are not regulated and unfortunately some do not have you best interest in mind.
Today, there are numerous forex brokers competing for your business and it is your responsibility to do the appropriate research and due diligence to find the most suitable forex broker for you. While most of the big name forex brokers are regulated, some of the smaller forex brokers are based in offshore locations where regulatory bodies are non-existent
Devaluation Risk
What is devaluation or devaluation risk? Devaluation takes place when a country deliberately adjusts its country’s currency downward relative to another country’s currency.
Devaluation is a monetary policy tool utilized by countries that have a fixed rate of exchange. Devaluation is determined by the government which issues the currency and is the direct result of governmental activity. One of the primary reasons a country devalues its currency is to prevent trade imbalances. When a country devalues its currency it reduces the value in the country’s exports which makes the exports less expensive and in turn makes the exports more competitive on the open global markets.
If a country devalues its currency downward the country may have to raise its interest rates to control inflation. Devaluation makes the items sold in another country more attractive as the price of the item declines relatively in their currency.
Fraud Risk
Another type of risk which you need to be aware of as a forex trader is fraud risk. In the early days of on-line trading fraud was more rampant in the forex industry. In recent times, there have been significant improvements in weeding out unscrupulous brokers. In an attempt to reduce your chances of working with an unscrupulous broker, you should research the forex broker that you doing business with.
Also as noted earlier, you should find out if the broker is regulated within the country that they are doing business in. With a little research online you can find a good deal of information pertaining to well established and not so well established forex brokers.
In closing, to be successful as a forex trader you need to fully understand the different type of risks you face, and how these risks can affect your trading positions. Managing risks in forex is your primary task as a trader. Many of the risks discussed within this article, if properly monitored and factored into your trading strategy, can help you protect and grow your trading portfolio.
Forex Risk Management
As a forex trader, you are first and foremost a Risk Manager, responsible for managing your money and the level of risk within your portfolio. One of the fundamental rules in forex risk management is that you should not risk more than you can afford to lose. One of the biggest mistakes forex traders make on a consistent basis is the aggressive use of leverage; some often utilizing the maximum amount which their forex broker offers. This is clearly a recipe for disaster which will be realized sooner than later by overly aggressive traders.
In addition, controlling one’s emotions plays an important role in your overall risk management plan. If you are unable to control your emotions, you will make critical mistakes in your trade execution. When markets become volatile you need to control your emotions and respond objectively and with a cool head.
Becoming an informed trader with risk management in mind is not impossible but does take a good deal of discipline. You should have a structured well thought out plan which includes the various components of risk and how you intend to address each. Now’s lets take a closer look at some of the risks that forex traders need to pay careful attention to.
Margin Risk
Margin or leverage risk can play a significant role in forex trading. What exactly is margin trading? Margin trading allows you to utilize leverage. Usually, when you are placing a forex trade, it is necessary for you to put up only a portion of the total value of the position as good faith. Your trade is considered leveraged if you are able to enhance your position size with borrowed capital. The amount which is required to be placed upfront is deemed as the margin requirement. Many forex brokers allow their forex trading clients to leverage up to 100:1. But just because they allow such high leverage, doesn’t necessarily mean that is it a good idea for you to use it.
Political Risk
Political and economic risk can play a significant role in how you trade within the spot forex market. Elections are taking place constantly throughout the world. Economic and political factors can alter the investment landscape within a specific country, which can generate risk for forex traders.
During elections there can be moments of political instability and uncertainty within a country, which usually leads to greater volatility in the country’s exchange rate. As a rule of thumb, you should keep a close eye on pre-election polling so that you will not be surprised with the voting results.
When a change in government takes place within a country the ideology of the residents of the country may also change due to the new political environment. Changes in political parties can shift the new government’s approach to monetary and fiscal policy.
When unexpected elections take place within a country, additional uncertainties can arise. Unexpected elections can arise from various instances such as a vote of non-confidence, corruption or scandals. Usually, unplanned elections can be very problematic and increase the volatility of a country’s currency. In addition, unexpected elections can trigger other events such as protests or labor strikes. It is extremely difficult for you to anticipate these events, however the more cognizant you are regarding the political affairs within a country, the easier it will be for you to react to sudden changes.
Making use of an economic calendar will allow you to track when important scheduled news events are going to take place so that you can better plan and strategize your trades. In addition, most forex brokers offer their trading partners live streaming news. You should be monitoring current events and news which may impact your trading positions.
Learn What Works and What Doesn’t In the Forex Markets….Join My Free Newsletter Packed with Actionable Tips and Strategies To Get Your Trading Profitable…..Click Here to Join
Interest Rate Risk
Another major component of Forex risk is interest rate fluctuations. We know that when an entity or institution borrows funds from a given lender, the lender will provide those funds in exchange for a given interest rate on the loan.
The rate of interest charged will typically be determined by the amount of risk the lender takes. Usually, borrowers who are considered high risk will pay a higher interest rate on a loan. Conversely, borrowers who have a lower risk profile will invariably pay lower interest rates over the life of the loan.
Central Banks are responsible for setting monetary policies within their counties to ensure economic growth and stability. These fluctuating interest rates in the foreign exchange markets drive numerous decisions for traders.
It is important to note that a country’s interest rates and currency exchange rates are often linked hand and hand. By carefully monitoring interest rate changes, you will know where big institutions are investing their assets in order to receive the greatest return possible.
Many times big institutions focus on the carry trade, which is an interest rate differential based trade. Generally, the higher yielding interest rate currency pairs attract greater demand.
Exchange Rate Risk
Exchange rate risk in its simplest context is the risk exposure posed by the dynamic changes in the value of currency. Exchange Rate risk is of particular importance to companies that have operations in multiple countries or that regularly export their products.
Volatility Risk
Volatility plays a significant role in accessing foreign exchange risk. Volatility risk describes the degree of fluctuations within the markets and should certainly be included in a trader’s thought process.
When you are trading you should be aware of the rules and regulations that the forex broker abides by. It is of the utmost importance that a forex broker is regulated appropriately in the country that they do business in and maintain the proper reserves in case the other party associated to the trade cannot cover their trading loses.
As a forex trader it is not always easy to determine the amount of operational risk that you are exposed to, however, as a trader it is your responsibility to research and evaluate a business’s operation in an effort to reduce operational risk as much as possible.
Broker Risk
Prior to handing over your capital, you want to make sure you do your homework and find a reputable forex broker. Broker risk, can impact you and your working capital in numerous ways. Some forex brokers are not regulated and unfortunately some do not have you best interest in mind.
Today, there are numerous forex brokers competing for your business and it is your responsibility to do the appropriate research and due diligence to find the most suitable forex broker for you. While most of the big name forex brokers are regulated, some of the smaller forex brokers are based in offshore locations where regulatory bodies are non-existent
Devaluation Risk
What is devaluation or devaluation risk? Devaluation takes place when a country deliberately adjusts its country’s currency downward relative to another country’s currency.
Devaluation is a monetary policy tool utilized by countries that have a fixed rate of exchange. Devaluation is determined by the government which issues the currency and is the direct result of governmental activity. One of the primary reasons a country devalues its currency is to prevent trade imbalances. When a country devalues its currency it reduces the value in the country’s exports which makes the exports less expensive and in turn makes the exports more competitive on the open global markets.
If a country devalues its currency downward the country may have to raise its interest rates to control inflation. Devaluation makes the items sold in another country more attractive as the price of the item declines relatively in their currency.
Fraud Risk
Another type of risk which you need to be aware of as a forex trader is fraud risk. In the early days of on-line trading fraud was more rampant in the forex industry. In recent times, there have been significant improvements in weeding out unscrupulous brokers. In an attempt to reduce your chances of working with an unscrupulous broker, you should research the forex broker that you doing business with.
Also as noted earlier, you should find out if the broker is regulated within the country that they are doing business in. With a little research online you can find a good deal of information pertaining to well established and not so well established forex brokers.
In closing, to be successful as a forex trader you need to fully understand the different type of risks you face, and how these risks can affect your trading positions. Managing risks in forex is your primary task as a trader. Many of the risks discussed within this article, if properly monitored and factored into your trading strategy, can help you protect and grow your trading portfolio.
