Forex Trading Risks
Forex is promoted as a way to earn money from the comfort of your home.
12:15 25 March 2020
Advertisement does not lie. Thanks to the modern digitized economy, you may connect to global markets through the Internet and monetize your knowledge of trends.
However, like any kind of investment, currency and stocks trading has their own inherent risks. Any reliable broker will highlight these dangers in their promotional material. But how serious are these threats?
Here is a look at the most common risks present in Forex trading. Exchange rates that allow you to profit are constantly in flux, influenced by various factors of micro- and macroeconomic nature. The dangers are varied ranging from technical glitches to geopolitical hits.
Uncontrollable Financial Markets
The market you trade in is beyond your control. It carries its peculiar systematic risks, i.e., a risk that covers the entire market and may not be mitigated with the help of diversification. Its opposite - unsystematic risk - would only affect a particular asset, region, or sector.
With regard to Forex trading, market risk includes all the numerous factors that could move exchange rates. From a domestic policy of separate states to international military conflicts, the list is lengthy.
For example, consider the collapse in the price of crude oil in March 2020. The coronavirus pandemic and the failure of OPEC+ exporters to agree caused a crash the ripples of which were felt all over the world.
Currencies like the Russian Ruble were hit the most severely, as their value is closely linked to global oil prices. Individuals with savings in US dollars gained an opportunity to capitalize on the soaring exchange rate. This is how market risk may turn in handy. General systematic finance risks include the following factors:
- Estimates of inflation, growth, and employment: These may sway decisions made by the Central Bank with regard to monetary policy and, therefore, interest rates.
- Various government announcements concerning economy and finance: Speculators may react to any such announcements by buying or selling large volumes of currencies on global markets. This, in turn, affects the rates.
- Elections: Changes in the government system could affect rates unfavorably or favorably. This depends on the image and intentions of the new regime.
- Strikes: Worker protests, when their scale is significant, could lead to economic disruptions in the country. This may also sway the value of its currency.
- Geopolitical tensions, including military conflicts: For instance, a war breaking out in an oil-producing region propels global oil prices up, along with currency rates of exporting nations.
- Terrorist attacks.
- Natural disasters.
- New regulations, laws, or taxes.
Risks of Leverage
Leverage is a double-edged tool. On the one hand, it maximizes your buying power, allowing you to trade with volumes well beyond your deposit amount. On the other hand, it boosts your risks. For example, with 1:100 ratio, you may open a position for $10,000 using only $100 of your own. If the trade returns a loss of $100, this constitutes a loss of %100. If you gain $100 in profit, this translates into 100% profit. With both upward and downward movements magnified, you may gain or lose more than you would without leverage from your broker. Therefore, it is vital to assess your risks before using leverage to the fullest.
Liquidity means that a market has many buyers and sellers willing to trade certain assets. It is therefore easy to open and close positions. Supply and demand will also play a minor role in changes in the value. Sometimes, even the currency market experiences periods of inhibited liquidity. This translates into higher trading costs, which may be observed on weekends, during bank holidays, and outside the US and European sessions.
In Forex, your counterparty is your intermediary, i.e., broker. Make sure the firm you are dealing with is officially licensed to operate in your region and its practices are subject to scrutiny by state authorities.
Sometimes, traders may not withdraw their profits due to bankruptcy of the broker or some regulatory restrictions. Do some thorough research before opening a live account. In Forex and life in general, it is best to be safe than sorry.