Forex Trading: 4 Major Risks & How to Manage Them

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Forex trading risk management should be a top priority as a forex trader. Like it or not, this should be the first thing you think about in the morning and the last thing you least think about before bed. To put it simply, forex traders should live and breathe risk management.

Enter the online world, and all of a sudden, risk can become completely rampant, in part due to the speed at which transactions can take place. But the speed of transaction, the instant gratification, and the adrenaline surge of making a profit in less than 60 seconds can often lead to gambling instincts, to which you can easily succumb. Hence, you might turn to online trading as a form of gambling and not as a professional that requires legit speculative habits.

Speculating like a trader is not poker. The difference between gambling and speculation is risk management. Real traders will always try to reduce the amount of potential loss and get the most returns out of each trade.

With Risk Comes High Reward

Well, that does not always echo the truth because other factors are in play from time to time. One of the things novice traders must learn when it comes to Forex risks is that the best traders are not ones that know how to skyrocket their profits but rather those that know how to curtail their losses.

Therefore, knowing the risks you’re exposed to will help mitigate those losses because you already understand some factors that can be managed accordingly, depending on the case.

Understand The Risks of Forex Trading

Forex Trading

There is a universal reality you have to accept when it comes to forex trading and that you have to get in the habit of assessing your risk first, then getting into trades. No other way around.

The scary fact is that almost 90 percent of forex traders lose their money. If that doesn’t voice how risky Forex trading is, nothing will.

1. The Exchange Rate Risk

The foreign exchange risk, also known as exchange rate risk, occurs due to exchange rate fluctuations. Is the risk that a company’s financial position or financial performance will be impacted by changes in the exchange rates between currencies.

This risk happens when you engage in a financial transaction or maintain a financial report in a currency other than where it is headquartered. For instance, if you’re based in France and do business in China – i.e., receive financial transactions in Chinese yuan – then report your financial statements in French euros, you’re exposed to foreign exchange risk.

All financial transactions accepted in Chinese yuan must be changed into euros to be listed on your income statements. Fluctuations in the exchange rate would be a risk, one that a dependable Forex broker could help you dodge.

What causes foreign depreciation risk? The risk can be caused by the depreciation of the appreciation of the foreign currency, base currency, or a combo of these two. It’s a great risk to consider for importers/exporters and companies that trade in international markets.

2. The Credit Risk

The credit risk enters a larger and much more complex category, yet, limited by the laws of each state in the G-7 nations. This risk cannot affect the average traded since they can be on the other side of the trade.

The idea is that traders need an institution or a Forex broker to carry out trades. If the institutions in question fill out for bankruptcy, what else do you think would happen to the investor’s money?

One thing to check for is if these institutions or brokers are regulated: if they’re legit, check for the compensation plan in case of insolvency.

You will find helpful information if a credit risk happens with a full guideline on how to recover your money.

3. The Country and Liquidity Risk

Liquidity stands for the ability of a trader or a company to convert something they own in cash immediately and at a desirable price. Here are two major types of liquidity risk:

  • Funding liquidity refers to the lack of a company’s ability to pay for its obligations. It occurs due to the company’s unsuccessful administration or financial crisis, which leads to a fund reduction.
  • Market liquidity happens when sole traders or companies can’t buy or sell an asset at the price they want. As a result, they either have to sell/buy their assets at an unsatisfying value or wait for long.

4. The Leverage Risk

Here’s where most novice traders tend to heighten Forex trading risks without even realizing it. That’s where the double-edged sword comes in.

The higher the amount of leverage on the capital you apply, the greater the risk that you will assume. However, higher leverage is not always a bad thing if you know how to make use of it.

To be annoyingly honest, for many traders, it isn’t really worth using leverage at all. That’s especially true with novice traders who can end up depleting their trading accounts quite rapidly.

Caution needs to be heeded, though, as this also makes trading more enticing, and rapid losses can happen. Even professional traders are at least very cautious of the risks involved in using leverage.

Emotional & Risk Management Strategies

Other than handling all the physical aspects, traders must be able to master their emotions as well.

You will never reach the level where you want to get profits from trading if you’re unable to master your emotional side.

More than often, traders get trapped in shifting market points with market sentiments – one of the most common Forex trading risks. Stubborn traders will never make Forex trading the best option to earn.

With the lowest possible loss, traders should leave the market when they get to know their slip-ups. The longer they wait, the more substantial capital they lose.

Forex trading remains one of the greatest financial markets with the potential of massive losses and profits likewise. In order to reduce the potential of financial disaster, you must, from the very beginning, have some Forex trading risk management strategies in place.

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Author: Trevor Davis

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