Just like any other investment, Forex trading subjects the traders to potential risks in each of their trades. For huge financial institutions like banks, they are the major market players and they use Forex to lower down the risks of currency fluctuations. They are capable of using complex algorithms in order to reduce the risks involved. But for retail traders, you must take extra steps to fulfill such a complicated task. Through a good risk management plan, you can minimize the risk you can get yourself in. Aside from that, you can know each FX risk so you will know how to defend your trades from it.
It is a type of risk that is primarily caused by changes in the currency value. Exchange rate risk can be caused by the continuous supply and demand of currencies. Volatility shift also takes part in it. To be able to limit the exchange rate risk, you must use these methodologies;
- Position Limit
- Loss Limit
- Risk/Reward Ratio
It is the type of risk that involves the profit and loss that comes from the fluctuations in spreads, maturity gaps, and amount mismatches. Interest rate risk is common among currency swaps such as options, forward upright, and futures. To avoid this risk, you should avoid the mismatches according to their maturity dates. Also, you need to check the interest rate environment for any changes that could affect your gaps.
It is a risk that arises when a currency position is not paid according to what is agreed, either due to the involuntary action of the counterparty or the voluntary action. This concern is mostly the concern of huge banks and financial institutions. Some forms of credit risk include settlement risk, replacement risk, and counterparty default risk.
This risk is caused when a trade is prevented from pushing through at a specific period of time. This can be prevented totally if the trader promptly liquidates unfavorable positions. Also, be wary of using limit orders and stop-loss because such orders may not be executed during these very liquid markets.
Normally, low trade collateral and margin deposits are needed in foreign exchanges. With these margin policies, a higher degree of leverage is permissible. But these small price movements can somehow create huge, immediate losses in the amount that the trader invested. To avoid getting bankrupt, you must not overuse leverage as it can also increase losses, the same as how they increase your chances of getting profitable.
There are unforeseen losses caused by miscommunication, mishandling of orders, and error in the confirmation of the order. This is the transaction risk that might come unannounced. This is usually the error of the third-party institution.
This risk is usually due to the trader’s insufficient capital. Despite having a correct long-term view of the market, the short-term losses that come along the way may be hard to handle. This could lead to closed accounts because the trader couldn’t meet the marginal call to sustain the open position in Forex Trading.