The forex market is a highly volatile market. It sees a daily volume of US$6.6 trillion worth of trades, making it the largest and most liquid market worldwide. While the potential exists for global traders to make a significant profit, sudden market fluctuations can also lead to massive losses. Knowing how to mitigate the risk of loss is key to being a successful trader. So, is forex risk high? This is what we’ll examine in this article.
The use of leverage is common in forex. The concept involves the use of borrowed funds to increase one’s trading position. A forex trader typically borrows funds from a forex broker to be able to trade larger positions in a specific currency. The forex market is renowned for offering higher amounts of leverage than other financial markets. Traders will often base the size of individual trades on the leverage that they want. Margin requirements and leverage ratios are often dependent on the broker.
Leverage does however come with risk during volatile market conditions and can amplify losses significantly. Traders are always advised to stay prudent to avoid losing large sums of capital. One of the ways they do this is by implementing stop-loss orders. This is a trade order to exit a position at a specific price level.
Exchange rate risks
The forex market is open 24 hours a day, five days a week, and is active across several time zones. This means currencies are traded at different prices at various times during a trading day. As a result, exchange rates can change before trades are closed. Exchange rate risks may arise due to adverse movements in exchange rates. This risk increases in the time differences between the start of a contract and when that contract settles.
Interest rate fluctuations & currency crisis
Interest rates can impact exchange rates. If interest rates rise in a country, the strength of its currency will increase too. If interest rates decrease, however, the currency will also weaken as investors may withdraw their assets. The difference in currency values may cause forex prices to fluctuate. Further, currency crises like the devaluation of a country’s currency and widespread economic damage may also impact forex trading significantly.
Reducing risk through a trading strategy
It’s apparent that a range of economic variables can have a negative influence on the forex market. Reducing the risk of losing money on forex trades during these periods becomes paramount.
A forex trading strategy can help a trader better manage the potential for risk. It provides the framework for executing specific trades. A strategy is typically adjustable based on the performance of trades and trading goals. It accommodates the size and type of trades, trading style and trading techniques. It also considers the level of risk you’re willing to incur, market environments, the potential for profit or loss, etc.
Opening a demo forex trading account
If you’re only now starting your trading journey, opening a demo account to practice your trades is very useful. A demo account offers a risk-free trading environment in which traders can use virtual funds to test their trading strategies. Demo accounts also give traders the chance to evaluate the level of risk they’re prepared to take on before moving to a live trading environment.
Live forex trading accounts
CFD forex brokers offer a range of trading accounts. Each account comes with its own set of requirements or restrictions. Forex traders usually select trading accounts based on their trading skills and needs. A trader will normally move to a live trading account once they’re gained sufficient experience to trade with real money. Other factors that traders should consider when moving to a live trading account are:
- How much money they will fund the account with
- Risk tolerance
- How much time do they have to trade every day?
- Trading objectives
- Trading style and techniques
- Their ability to adjust a trading strategy or trading technique when the need arises
- Their ability to react to market spikes or volatile market conditions
Forex risk management strategy
How a trader manages risk is often dependent on their intrinsic nature, knowledge, skills, and expertise. Someone prone to emotional outbursts or who is too impulsive may end up losing large amounts of capital when trading. This is what makes having a proper risk management strategy key. It provides the rules and guidelines to mitigate risk and makes trading forex more manageable. A risk management strategy will also help a trader keep their emotions under control to make better trading decisions.
There are several strategic ways forex traders can try and protect themselves from the risks associated with trading. Quantifying potential loss is one of the ways. This is achieved by assessing the risk of a particular trade in advance and making a trading decision accordingly. If the risk incurred to too high or low enough to execute the trade.
Having a proper understanding of leverage is also incredibly important. As we’ve discussed, leverage is highly volatile and has the potential to magnify losses exponentially. Utilise leverage in a way that makes sense and limits the dangers that using it could impose. Also use tools to reduce the loss of capital, e.g., stop-loss or take-profit orders.
Managing risk also requires learning how to analyse market data using technical and fundamental analysis. This is especially important if one considers the volatility of the forex market and how price movements are impacted. Geopolitical news and events and environmental instabilities can influence market performance dramatically. Knowing how to interpret the impact of these factors may help to improve a trader’s ability to better assess trading risks.
Trading forex comes with great responsibility because the risk of losing large sums of money is high. Making informed trading decisions comes with understanding what risk is and knowing how to manage it properly. There is no magic formula that will remove risk from the equation. Having the proper tools and knowledge in place to mitigate the risk, however, will help you become a better trader. Why not visit the T4Trade Academy online and enjoy an exclusive variety of powerful trading resources? This includes educational webinars, podcasts, and videos on demand to improve your trading skills. Also, explore different trading strategies and get answers to your forex queries.
Disklaimer: This material is for general informational & educational purposes only and should not be considered investment advice or an investment recommendation. T4Trade is not responsible for any data provided by third parties referenced or hyperlinked, in this communication.