The foreign exchange (forex) market is the forum for selling and buying currency pairs from across the world. It is the objective of forex trading to yield profits from the simultaneous exchange of currency pairs at the forex market. The forex market witnesses the highest trading volume, because of which the forex assets are referred to as highly liquid assets. The forex trades comprise of spot transactions, forex swaps, forwards, options, and currency swaps. However, there are risks aplenty in the forex market. The risks of forex trading result in huge losses. Find out more about the risks of forex trading right here.
Risk Factors in Forex Trading:
1. Exchange rate risk
Exchange rate risk occurs due to the changes in currency value. It happens due to the impact of the continuously volatile shift in the balance of supply and demand in currencies worldwide. Exchange rate risk can trigger significant losses in forex trading.
2. Interest rate risk
The interest rate of currencies has an effect on the exchange rate of the currency pair. If there is a rise in the interest rate of a country, then there will be an improvement in the financial strength of the currency. This improvement is due to the inflow of investments in the assets of that country, as a stronger currency triggers higher returns. Conversely, if there is a fall in the interest rate, the currency will decline in strength, as investors begin to withdraw the investment. Due to the circuitous impact of the fluctuating interest rate on the exchange rate, the difference between the values of the currencies can trigger dramatic changes in the forex prices, thereby incurring losses due to interest risk.
3. Credit risk
Credit risk is the probability that an outstanding position of currency may not be met with repayment due to involuntary or voluntary actions by the counter-party. This risk of forex trading usually concerns banks and corporations. For individual forex traders, the risk of credit is not so high.
4. Country risk
If a forex trader considers the options of investment in currencies, he must assess the stability and structure of the country that is issuing the currency. In the third-world and developing countries, the exchange rates are in tandem with the US dollar and other currencies of developed countries. In such situations, the central banks should possess an adequate reserve of currencies for the maintenance of fixed exchange rates. The country risk happens because of the balance of deficits in payment, resulting in the devaluation of the currencies. Such a situation can have substantial impacts on currency prices and forex trading.
5. Liquidity risk
Even though the forex market experiences high liquidity, there are still periods of illiquidity that result in losses in forex trading. The liquidity risk prevents the forex trader from liquidating an unfavorable trading position, thereby incurring losses.
6. Marginal or leverage risk
In forex trading, the leverage requires a nominal initial investment called margin for gaining access to significant forex trading in international currencies. There can be price fluctuations in the margin calls, which require the forex investor to make the payment of an additional margin. If the market condition is too erratic, excessive employment of leverages can trigger huge losses in the initial investments due to marginal or leverage risk.
7. Transaction risk
The transaction risk is an exchange risk that is associated with the time difference between the proposition and settlement of the contract. The forex trading operates based on twenty-four hours, resulting in the changing of the exchange rates before the settlement of the trade. And so, the currency pairs get traded at a variety of prices at different hours of the duration of the trade. The higher the differential of time between the agreement and settlement of the contract, the higher is the risk of the transaction. Any difference in time triggers the fluctuation of exchange risks, resulting in taxing transaction costs.
8. Risk of ruin
Even if the long-term or medium-term market analysis and forecast of an individual forex trader may be precise, the unpredictable short-term losses can expose the trader to the risk of ruin. The risk of ruin disables a trader from meeting a margin call and may thereby close out his position at a substantial loss.
In-depth research is mandatory for risk-free forex trading. The risks of forex trading will always be there, but engaging trustworthy and reputable forex brokers can help to mitigate the losses. Stay aware of the forex market risks and make your investments more carefully to prevent losses during trading.