Forex Trading Risks
Trading Forex can be risky if you don’t follow the rules of risk management. It is important to use proper risk management, work out lot sizes, only risk 2% or 3% on any one trade, and always set a stop loss. In addition, it’s important to back-test - nothing will teach you as much as the markets will. Sometimes I get students to say to me, “Oh, I haven’t got time to back-test,” they are not the people still trading 6 months later. Name one sportsman or woman who doesn’t watch the replay of a match they have been in to see what they could have done better.
understand the movement of pairs and the movement of the markets. Follow one educator, and one strategy and practice on demo and write down what you think you did right, what you think you did wrong and how you think you could have improved the outcome of a trade you have just taken.
It’s important to understand the language and the basic principles of Forex. If you dive straight in to trade on a live account, yet you can’t even define to me what Forex is, then you are unlikely to become a successful trader as it shows you have not got the desire to get a good foundation in how to trade Forex.
By only risking, say, 2% on any one trade, you would have to lose 50 trades in a row and that is highly unlikely. It will keep you in the game. Set a trade goal, a daily goal, and a weekly goal, and don’t get greedy. Greed can cost you money. You might make say 40% for argument’s sake on one trade, more than your goal for the week, shut the computer, and walk away for the rest of the week. If you do decide to go back in, then just risk 6% ie 3 trades x 2% and if you lose them you are still ahead of your weekly goal, if you don’t you have made more. But don’t just go in and keep trading, it invariably never ends well.
Exchange Rate Risk
Exchange rate risk is the risk caused by changes in the value of the currency. It is based on the effect of continuous and usually volatile shifts in the worldwide supply and demand balance. For the period the trader’s position is outstanding, the position is subject to all price changes. This risk can be quite substantial and is based on the market's perception of which way the currencies will move based on all possible factors that happen (or could happen) at any given time, anywhere in the world. Additionally, because the off-exchange trading of Forex is largely unregulated, no daily price limits are imposed as existing for regulated futures exchanges. The market moves based on fundamental and technical factors - more about this later.
The most popular methodology implemented in trading is cutting losses and riding profitable positions, in order to ensure that losses are kept within manageable limits.
Interest Rate Risk
Interest rate risk refers to the profit and loss generated by fluctuations in the forward spreads, along with forwarding amount mismatches and maturity gaps among transactions in the foreign exchange book. This risk is pertinent to currency swaps; forward outright, futures, and options. To minimize interest rate risk, one sets limits on the total size of mismatches. A common approach is to separate the mismatches, based on their maturity dates, into up to six months and the past six months. All the transactions are entered in computerized systems in order to calculate the positions for all the dates of the delivery, gains, and losses. Continuous analysis of the interest rate environment is necessary to forecast any changes that may impact on the outstanding gaps
Leverage Risk
Low margin deposits or trade collateral are normally required in Foreign Exchange, (just as with regulated commodity futures). These margin policies permit a high degree of leverage. Accordingly, a relatively small price movement in a contract may result in immediate and substantial losses in excess of the amount invested. For example, if at the time of purchase, 10% of the price of a contract were deposited as margin, a 10% decrease in the price of the contract would, if the contract were then closed out, result in a total loss of the margin deposit before any deduction for brokerage commissions. A decrease of more than 10% would result in a total loss of the margin deposit. Some traders may decide to commit up to 100% of their account assets for margin or collateral for Foreign Exchange trading. Traders should be aware that the aggressive use of leverage will increase losses during periods of unfavorable performance.
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