The Forex exchange market is one of the largest in the world, owing to its high trading volume, making Forex assets highly liquid. Nevertheless, due to its leveraged products, there are many types of risks associated with it. However, as opposed to the stock market, traders can enjoy more profits if they can manage the risk. This is because they have very few currencies to choose from, instead of thousands of companies to sift through while trading in stocks.
Let’s look at the different kinds of risks associated with Forex trading:
Leverage requires a small initial investment, which is your margin, allowing access to foreign currency traders. A trader may be required to pay additional margin in case of margin calls due to price fluctuations. Aggressive use of leverage during volatile market conditions can increase the risk of losses for traders.
Transaction risk comes as an exchange rate risk, resulting from the time difference between the contract start and settle date. The greater the time difference between entering a contract and settling it, the more transaction risk there is, as currencies can be traded at different times during trading hours and at different prices.
Interest Rate Risk
Another risk you should be aware of and look out for is interest rate risk. As interest rates rise, they raise a currency’s value, because investments tend to pour in, resulting in higher returns on the trading of that currency. On the other hand, the risk for trading any currency increases if the interest rates of the country fall, lowering investments and resulting in a drop in the value of the currency.
When you are trading in the Forex market, there must be a company that is providing you with assets. If the broker or dealer in a transaction defaults, it is referred to as counterparty risk. Spot and forward contracts are not guaranteed by the exchange or clearinghouse in Forex trades, which can result in a counterparty risk due to solvency of the market maker.
Before choosing a currency for trading, traders should assess the stability of the issuing country. Usually, the currencies of third world countries are fixed to a world leader, such as US. Any frequent balance of payment deficits can devalue the currency and impact Forex trading and prices.
As Forex assets are liquid, if a currency is devaluing, investors will immediately start to withdraw their assets from that currency, leading to further devaluation. Then, if an investor continues to trade in that currency, their assets can become illiquid, resulting in insolvency from dealers.
There are thus, many apparent risks associated with Forex trading and if you are not smart about managing losses, you may soon be facing trouble. On the other hand, risk is always present in trading, and as a trader, if you are able to research well and be proactive, you can minimize your losses. To get started with Forex trading and for more tips and strategies, visit ETX Capital.