When trading, you can take a long position on one currency and, at the same time, take a short position on another. As a result, you will make money when one currency rises (long position) or when the other currency falls (short position).
Making money off the difference between currency values is what’s known as forex, and it isn’t for the faint-hearted. For starters, in forex, there are no centralized markets to facilitate your trades like those in stock exchanges.
Also, the risks in forex go well beyond an individual firm’s or the entire market’s performance. However, if you understand the risks you and trade cautiously, you can make money from forex. So let’s look at the risks linked to forex trading and how you can mitigate these risks.
The Risks of Forex Trading Include:
Exchange Rate Risk
Forex traders use one country’s currency to buy the currency of another country. Variations in the value of both currencies will impact your profit or loss. For instance, if you were traveling to the US from France, 10 Euros (€) will get you about 11.6 Dollars ($) as of 9th October 2021.
When you buy and sell currencies on forex markets, you’re wagering on how various currencies will change in value against one another. All things constant, if you buy a currency that increases in value against the currency it’s paired with, you get a profit. On the other hand, if the reverse happens and the currency reduces in value, you will incur a loss.
Exchange rates are closely related to a country’s interest rate. Rising interest rates attract investors to a country. When interest rates drop, it will lead to disinvestment and a less valuable currency. As a trader, you must study this relationship before venturing into a trade.
Using leverage when trading forex isn’t that different from using it when trading options and stocks. When you trade on margin, you get a loan from your broker to fund trades that need cash in excess of what’s in your account.
If the trade loses, you might get a margin call demanding that all cash above your original outlay come back into compliance. While leverage can greatly increase profits, it can do the same with losses. Forex markets are volatile; the slightest price shift can trigger a margin call.
Country risk can be divided into two categories, namely:
Instability in a country will affect its currency negatively. For instance, when a hostile event happens, or traders fear one might happen, investors will change their money into another currency, which will devalue the country’s currency.
You don’t want to be on the opposing side of things when a devaluation happens. It can happen fast and lead to illiquid markets. You run the risk of being stuck in a trade.
You can face another kind of country risk when a country intentionally devalues its currency. It’s essentially not a bad practice; it’s just one kind of monetary policy where a country purposely decreases the value of its currency to compete more effectively in world markets.
How Can You Mitigate These Risks?
When venturing into forex, start with an amount of money you can afford to lose. If you get winning trades, withdraw that amount. Don’t let early success fuel your confidence such that you make more significant and riskier trades. Try using a demo (practice) account via a trading platform prior to entering forex trades and using actual cash.
When you make actual trades, use the same tools used when trading stocks. For starters, use stop-loss orders and spread your cash across numerous trades rather than just one pair.
Have A Comprehensive Strategy in Place
Before you venture into forex trading, ensure this move is part of a well-built and diversified investing strategy. Don’t allow slipups in the new forex trading world to damage your long-term financial well-being. Consider hiring an investment advisor to ensure that you make the right investment decisions, thereby guaranteeing your financial well-being.
All in all, forex trading comprises several risks, as illustrated above. Of course, you can’t totally evade all these risks, but you can learn how to lessen them and as a result, you’ll learn more about the trade and make good profits in the long run.