8 Major Risks That You Should Evaluate In Forex Trading
It’s not a secret that the Forex or foreign exchange industry is HUGE right now. In fact, it is now regarded as the largest currency trading market ever existed.
Forex market stands for foreign exchange market where traders buy and sell currencies from around the world.
Likewise the stock market, the ultimate goal of a Forex trader is to make as much profit as possible by buying the currency at low rates and sell them at high prices.
Forex offers the flexibility to traders because of various currencies to choose from, as opposed to limited sectors and companies offering the stock market.
To make informed trading decisions, you need to familiarize yourself with the different risks associated with foreign exchange trading.
So, if you want GREAT results from Forex trading then you’ll have to evaluate these certain risks.
- Interest Rate Risk
- Country Risk
- Counterparty Risk
- Leverage Risk
- Transaction Risks
- Political Risk
- Liquidity Risk
Therefore, let’s dive right in.
Interest Rate Risk
Interest rate fluctuations have a significant impact on the exchange rate of a country.
The increase in interest rates typically strengthens a country’s exchange rate was due to an increase in investment since a stable currency generating higher returns to investors.
On the other hand, when interest rates fall of a country, its currency depreciates an investment they attract investors.
Because the relationship between interest rates and exchange rates, the resulting differential between different currencies can cause fluctuations in foreign exchange rates.
Central Bank of each country determines monetary policy and, therefore, interest rates. fluctuating interest rates play an important role in various trading decisions.
Experienced traders understand the importance of keeping up with changes in interest rates.
Many agencies are involved in carrying trades in which trades are based on interest rate differentials. Typically, the currency pair with the higher interest rates tend to attract the most attention.
Country Risk
When presented with a variety of currency pairs, traders need to consider the stability of the issuing country.
Developing and third world countries, such as Pakistan, have their currencies pegged to the leading currencies, such as GB Pounds or US Dollars.
In this case, the central bank maintains reserves to keep the exchange rate stable. The currency could be in crisis because of the balance of payments deficit, thus devaluing the currency. This can have a significant effect on Forex trading.
Since the investment has a highly speculative nature, if investors believe the currency will decline, they will issue their assets, thus devaluing the currency. Traders who do not follow market signals will face problems with liquidity and bankruptcy.
Where Forex trading is concerned, currency crises worsen credit risk, liquidity problems, and devaluation.
There are many examples of currency crises throughout history, such as the Latin American crisis of 1994 and the 1997 Asian financial crisis.
Counterparty Risk
Counterparty in the Forex market is the company with which you open and close trading positions, namely, broker or dealer.
Therefore, the counterparty risk refers to the broker or dealer defaults in certain transactions, either because of the lack of regulation or bankruptcy.
The best way to minimize this risk is to choose a broker who is registered with the regulatory body. To start trading Forex, you need to educate yourself and find a broker that is very good.
The latter can be done easily when you are exploring Forex broker and choose a trusted broker that fits your trading style.
For those who are facing trouble to choose a trusted Forex broker, I’m certain that this guide will be vastly helpful to you all.
Leverage risk
One of the most significant risks associated with foreign exchange trading is the leverage risk. Leverage refers to a small initial investment, known as margin, are made to benefit from greater market exposure.
While leverage is used to increase the return on investment, it also increases the losses. There are risks associated with leverage because of fluctuations in prices can cause a margin call, in which the additional margin to be paid by the investor.
Investors should be cautious when market conditions are unpredictable because it uses fast aggressive leverage can work against you and result in significant losses.
Transaction Risks
Risk trade order transactions occur when communication, handling and confirmation errors causing harm. The most common reason for transaction risk is the time difference between the start and completion of the contract.
Since Forex trading requires a plan at the time of 24 hours, the exchange rate is often changed before the trade is completed.
Such as the time difference increases, so does the risk of the transaction because it gives more time the exchange rate to fluctuate.
Political Risk
Political factors and economics play a large role in determining how you trade in the Forex market. Political events, such as elections take place regularly, and the results of these events can significantly affect the investment environment in the country.
During election season, there is a lot of uncertainty and instability in the country, thereby increasing the country’s exchange rate volatility.
Other political events, such as strikes, protests, and scandals, it can also cause fluctuations in the exchange rate.
Although it is not possible to predict such circumstances, you can minimize the risks by keeping a close eye on the political affairs of a country.
You should monitor current events that may affect your trading position so that you can react to unforeseen circumstances.
liquidity risk
In terms of liquidity and size, the Forex market is the largest in the world. Its high liquidity gives traders the ability to enter and exit the market with ease.
The high liquidity also means that changes in the demand and supply of assets will have a minimal effect on asset prices.
Although very liquid, this does not mean it is exempt from a period of low liquidity during weekends and holidays. Traders should keep a low liquidity risk this in mind because it causes a rise in the cost of a trade.
Conclusion
Due to various risks associated with foreign exchange trading, the resulting loss can be much higher than anticipated. Since trade is often exploited, the minimal cost could grow into liquid assets and major losses.
In addition, because many external factors affecting foreign exchange, there are many uncertainties associated with it.
Apart from this risk, Forex trading comes with substantial benefits, as well. Risks are always involved with trading financial assets and, as long as you are ready, they will have minimal impact on your returns.
So, Best Of Luck To Your Trading Carrer!
