The total transactions which happen in the Foreign Exchange Market exceed $5 trillion daily. Therefore, unlike many other markets including the stock exchange, the up and down trading can be done easily without having to put too much effort. For this reason, many people are increasingly getting into Forex trading, often without the needed experience and knowledge about the subject. This is a subject which can easily get you great profits in a very short time and just like any other venture with similar characteristics, it comes with risks. This article will tell you about the top 5 risks traders should consider in getting into Forex trading.
The state of the currency in a certain country undeniably depends on different aspects of that country which directly affects its economy, hence its currency. Before considering to trade the currency of a certain currency, it is essential that a trader does deep research into the structure and also the financial, economic, political and social stability of that country. This is especially important if you are looking to trade the currencies of third world countries which are fixed to a more leading currency such as the US Dollar. The banks of these counties are required to sustain the needed amounts of currency in order to maintain its exchange rate. However, if there are frequent deficits of payments by the country, their currency can eventually be devalued.
As a trader, you should always be up to date with the political and economic environment of the country that you are trading. In case you see that there is a possibility for the currency to devalue, you need to act fast and sell it before any further devaluing of the currency.
The whole basis of Forex trading is on properly leveraging the value of currencies. As a trader, you need a relatively small investment in order to gain access to the currencies across the world. This is called a margin. When there are constant fluctuations in the currency, as a trader you might have to pay additional margins to access the currency for leverage. When the market is extremely volatile, these margins can be excess and is able to subsequently lead to major losses.
This is why you need to always be conscious and in control, for the investments, you make for leverage.
Counter Party Risk
During any financial transaction, the company which provides an asset to an investor is called a counterparty. There is always a default counterparty risk regardless of how reliable and stable your transaction may seem which applies to Forex trading as well. The way Forex environment is created, there is no guarantee when it comes to spot and forward contracts. Therefore, when you do spot currency trading which means purchasing currency for immediate delivery, you get a counterparty risk with regard to the solvency of the market maker. To put it simply, counterparty risk means that the contract you make with the exchange of the clearinghouse when you purchase currency may not be fully met. This is a risk that a Forex trader has by default especially when it comes to spot trading.
Interest Rate Risk
A country’s interest rates always have a profound impact on its currency exchange rates. The reason for this is that when the interest rates are high, the amounts of investments that flaw into the country tends to be high to the value of assets being higher. Governments usually act proactively in order to keep the interest rates at a stable value in order to stop the investors withdrawing their funding due to low asset values.
Due to the nature of the economies worldwide, however, it is natural for the interest rates to fluctuate sometimes several times within a financial year. This is a risk that all the Forex traders tend to have since impacts of interest rate fluctuations can dramatically affect the Forex prices. Therefore, it is always good to keep a close look at a country’s interest rates if you are willing to trade its currency.
Forex trading system is all about making use of the value of currencies at strategic times to get the most profit out of the transaction. Transaction risk comes in this play traders do with the time. There is always a time difference between the time when a contract begins and to the time it settles that is where the risk is. To find out the domestic value of a certain currency, the foreign currency should be converted to domestic currency first. As the individual or the company negotiate the value of the trade, the rates can fluctuate drastically without prior notice.
Usually, the foreign exchange ratings happen on a basis of 24 hours during which the rates can change before the trade is settled.
Within these trading hours, currencies can be exchanged at different times at different rates. When there is a large time slot between the times you enter the transaction and it finally settles, the risk factor is higher for the exchange rates to fluctuate. The solution for this would be to decrease the time in between the initiation of the trade and the settling of the trade as much as possible.