With an estimated worth of $2.4 quadrillion, Forex is the largest financial market today. Many traders want to get into it; however, it can be tough to grasp for newcomers. It functions much differently than other markets as it is more volatile, global, and open 24/5, Monday to Friday.
For these reasons, forex trading is high-risk, and traders are more vulnerable. To protect yourself and your trades from losses, try to learn everything you can about Forex. For starters, read these 6 forex risks all traders should know and consider.
Exchange Rate Risk
Forex trading is essentially trading one currency value for another. However, currency worth is influenced by many factors beyond your control, such as a country’s interest rate or political events. This can make the value dramatically shift by the day.
So even when your deal is concluded, the currency worth can change when you receive payment. Depending on your side, an increase in the coin’s value can raise or lower your profits.
In Forex trading, the counterparty is the company that gives assets to the investor. For a trader, that’s the broker. So, counterparty risk is the so-called risk of default from them. In volatile markets, your brokers might refuse or become unable to pay you.
To avoid this unnecessary risk, always choose brokers licensed and regulated by reputable authorities like the SEC in the USA or the FCA in the UK. In addition, you should work with brokers with financial stability, i.e., those that can survive volatile market conditions.
Try a forex brokerage comparison tool to find your perfect broker today and ensure a safe forex trading session.
Interest Rate Risk
Central banks determine interest rates. These institutions are responsible for maintaining stability and can affect the country’s exchange rate.
The currency strengthens when interest rates go up due to the many investments coming in fast. This can be mitigated when inflation is placed in the picture because high inflation drives the currency down.
Long-time forex traders know this quite well, so they invest in currencies with higher interest rates and withdraw from currencies with lower interest rates, which plummets their worth even more.
The dangers arise when the traders’ predictions on interest rates turn out wrong. In these cases, the negative consequences can echo throughout the entire forex market.
Currency worth is directly linked to the country it comes from. Besides interest rates, other factors that influence currency price are:
- International trade numbers (deficits and surpluses)
- Commodity, stock, and other capital markets
- Account balance
- Political events (referendums, international conflicts, unpredictable elections, etc.)
For instance, once the country gets into political turmoil, traders will instantly get out of any relations with its currency. You might get stuck with an illiquid currency if you don’t act in time.
Another risk linked to the country of your currency is intentional devaluation. This is especially common in developing countries that purposefully devalue their currency to reduce export costs and trade deficits.
Liquid markets are filled with sellers and buyers, and traders are constantly opening and closing at expected prices. Everything is perfect as traders finish deals quickly and at satisfying prices. Moreover, the spread (the amount between the seller’s and the buyer’s cost) is smaller.
FX overall is a liquid market; however, it can sometimes have low liquidity. This is especially emphasized for markets outside Europe and the US. So, even though FX is a liquid market, brokers can increase their spreads in low-liquidity situations. You can avoid this by working with brokers that offer fixed spreads.
Like stock and commodity trading, using leverage for FX trades is common and works similarly. When you borrow from your broker, you trade on margin. If the trade succeeds, you return the leverage and keep the profit. If it doesn’t succeed, you can have a margin call.
But remember: the forex market is highly volatile. As a result, any shift in price can lead to a margin call. This puts FX traders in a challenging position as they risk losing all their capital and energy to meet margin calls. To avoid liquidation, carefully assess your finances before using leverage in Forex.
Is Forex Trading Worth it?
Forex trading carries many risks, and there is room for significant losses. After all, currency rates depend on multiple factors nobody can control, including global and local politics.
However, it’s no coincidence forex is the largest trading market. The advantages outmatch its disadvantages and risk. If you want to avoid loss and disappointment, sharpen your trading skills. Stay ahead of news and trends, deepen your knowledge in FX trading, and only collaborate with regulated brokers.