The foreign exchange market eases the selling and buying of currencies across the world. The objective of forex trading is to make a profit by selling high and buying low. Unlike stock traders who must analyze numerous sectors and companies, online trading account forex traders can choose various currencies.
As a result of the high trading volume of the forex markets, forex assets are grouped under highly liquid assets. It is critical to note that there are numerous risks affiliated with forex trades that can cause huge losses. Read on to understand these risks.
Exchange Rate Risk
Exchange rate risk happens following changes in currency value. It depends on the impact of volatile and continuous changes in global demand and supply balance. When an online trading account position is dominant, it is vulnerable to price changes. The risk can be huge and depends on the market idea of the direction the currencies will move. This approach also depends on all factors that may occur anytime across the globe.
Here, there are no daily price limits as is the case on regulated futures exchanges. The market moves depending on technical and fundamental factors. One of the popular methods in the trading industry that maintains losses at manageable limits include:
- The Loss Limit
The loss limit is a standard that helps an online trading account owner to avoid huge losses that traders can make by configuring stop-loss levels. It is critical to activate a stop-loss order in place.
- The Position Limit
The position limit is the highest amount of any currency that a trader can carry at any single time.
- Reward/Risk Ratios
One method that traders utilize as a principle when regulating exchange rate risk is to calculate expected gains against potential losses. The concept is that many traders lose more than profit. One concept of trading, in this case, is to maintain the reward/risk at 1:3.
Interest Rate Risks
Interest rates can influence a country’s exchange rates. What happens when there is a hike in a country’s exchange rates? Its currency strengthens as a result of an inflow of investments in assets because a strong currency triggers high returns.
When the interest rates in a country fall, its currency weakens. This is because investors start withdrawing their investments. Interest rates can have an impact on exchange rates, and the difference between currency values can trigger a massive change in forex prices.
Transaction risks fall under the exchange rate risk. They are affiliated with time differences between the launch of a contract and the time it settles. Forex trading takes place round the clock, and this can trigger changes in exchange rates before trades settle down. Again, online trading account holders can trade different prices at varying times during trading hours.
A time difference between launching and settling a contract hikes the transaction risk. Time differences trigger a fluctuation in exchange risks. Organizations and people that deal with currencies face harsh and extreme transaction costs.
In a financial transaction, a counterparty or the organization that gives investors an asset. In this case, the counterparty risk is the default risk from the broker or dealer in a specific transaction.
The exchange rate does not trigger forward and spots contracts on currencies. The counterparty risk in a spot currency online trading account is triggered by the financial competence of the market maker. Amid volatile market conditions, the counterparty may refuse or be unable to comply with contracts.
There are numerous risks in the forex trading industry that can trigger huge losses than expected. However, forex trading comes with various benefits as well. Knowing these risks helps you to adopt strict measures to avoid them.
Before you can use a live online trading account, it is critical to test your strategy on a demo account. Practice helps you master your skills. If you make mistakes, learn from them, and accept the losses.