As forex resource sites can attest, forex trading is a high-risk, high-reward activity.
Both new and experienced traders have to be mindful of the various factors that can put their investment at risk. That’s why they work with their exchange broker to make sure they’re adequately protected.
The Basics of Risk in Forex Trading
In the forex market, trading focuses on the anticipated difference between two currencies.
It’s possible to overestimate or underestimate these differences, which will be reflected in the resulting profit or loss.
There are several kinds of risk a forex trader must deal with. Some of the most common risks are discussed below:
1. Exchange Rate Risk
This is the most prevalent risk in forex trading and is caused by changes in currency values.
Exchange rate risk depends on how the market anticipates a currency to behave. This behavior is linked to a huge range of factors that cannot always be predicted.
Safeguards against exchange rate risk include:
Position limits indicate the maximum amount of currency that a trader can carry at one time.
Stop-loss orders, or setting up loss limits, helps protect a trader from excessive and irrecoverable losses.
2. Country Risk
Since forex trading revolves around pairs of currencies, traders must keep an eye on the country risk their trades might be facing.
The situation of a country—for better or worse—affects the value of its currency. The currency might lose value quickly in the following scenarios:
- Political instability
- Economic uncertainty
- The occurrence (or anticipation) of a negative event
Sometimes, countries devalue their currencies to give their exports a better standing in the export market. This also qualifies as a country risk.
Thoroughly researching a country before trading its currency can help mitigate country risk, to an extent.
3. Leverage Risk
Also known as margin risk, leverage risk increases when a trader with a low account balance borrows money from their broker for conducting trades.
Leveraging can help increase profits, but incurring losses on such trades will put the trader in jeopardy.
Leverage risk can be avoided by playing it safe and adhering to one’s available account balance for financing trades.
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