Forex markets represent the largest share of the financial market. The activity that is recorded on any particular day is immense. The market capitalization of the forex market stands at over 5 trillion dollars. Every single day, traders exchange currency intending to make profits. The market is very liquid and the volatility is also high.
There are thus many kinds of risks associated with this market. If you are looking to get into the trade, you need to be aware of some of these risks. The following is a quick breakdown of some of the most common forex risks you should know about.
1. Transaction risks
During transactions, a trader will encounter several risks. Some of these could be technological while others are purely exchange-associated risks. The forex trade takes place over a day and many kinds of changes can occur before a trader makes the exchange. Usually, the time difference between the opening and closing of the trade increases the trade risk. Transaction costs increase as time goes on the market. Fluctuations are the main common factors that lead to the increase of price in the market.
2. Country-associated risks
The country of origin of a particular currency also determines the risk that is associated with that currency. The major currency is usually stable and they don’t come with many associated risks. The smaller currency from smaller developing economies though often have high risks. The financial institutions in these countries are not strong and they must be fixed to a major currency. As an example, take a look at the exotic pair USD/ZAR that is one of the most popular currency pairs in SA offered by South African forex brokers. Exotic pairs such as this one, are far more volatile than major currency pairs and their trading sometimes reminds riding a roller coaster. A traders account balance often referred to as equity in forex trading, determines the success a trader has. Traders who choose to solely focus on the major currencies have fewer risks facing their accounts.
3. Dealer risks
In the financial markets, the trader is always backed by a dealer. The dealer can be a broker or financial company that facilitates the trade. The risks that are associated with dealers can result in the loss of huge amounts of money. There are default risks which affect the account of the trader in case the transaction does not go as expected. In addition, volatility in the market can cause problems where a dealer might be incapable of honoring contracts. Apart from that, solvency issues in forex are also prevalent, especially in spot and forward contracts. These risks are thus some of those that can affect a trader indirectly.
4. Leverage risks
Trading currency is a highly rewarding affair. The forex market is one of those that gives traders a substantial amount of leverage. You can make a small initial investment but be allowed to access a much larger account. This means that a trader can make significant profits. The risk associated with trading with a larger account is also immense. To start with, many traders are not able to properly predict the market due to the volatility associated with it. The volatile market can abruptly result in a bad trade and lead to substantial losses in the market for traders who have used high leverage.
5. Interest rate risks
There are many aspects of the economy that can result in a fluctuating currency. The exchange rates are usually determined by the prevailing macroeconomic issues in a particular country. When the economy of a particular country is fairing well, the exchange rate goes in favor of the country. Traders can get returns for their investments. Such an economy thus attracts many traders from foreign economies. If the economy of the country is doing badly though, the outflow of currency causes the weakening of the currency. This also affects the exchange market. In a country where the currency is fluctuating rapidly, traders face heightened risks.
There are indeed many risks associated with the forex trading business. Most beginner traders are not fully aware of these risks and they might get into risky situations that they were not anticipating. As a trader, you need to be informed about the different market situations and how they might work against you. Among the many risks associated with forex trading, the above-listed are some of the most common. These risks can lead to unprecedented losses for the trader and possibly force them out of the trade.
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