How risky is forex trading? Top 3 risks
Forex trading is carried out in a decentralized global marketplace with the world’s foremost currencies pitted against one another.
Considered to be the largest and the most liquid financial markets, forex trading is open 24-hours a day; Monday through Friday, with daily trading volumes exceeding $5 trillion. With this type of access we really need to ask, how risky is forex trading?
While FX markets have their own set of advantages when compared to equities or the other exchange traded instruments for the comparatively higher leverage offered, customized contracts, greater trading opportunities due to longer operating timeframes, fewer instruments to analyse when compared to hundreds of companies listed on exchanges and so on, though some of these advantages could be a drawback in adverse market conditions. However, in spite of what many traders feel are key benefits of forex trading, it is definitely not a walk in the park. So, how risky is forex trading?
Financial markets, irrespective of the asset class are risky though the element of uncertainty may vary from one instrument to the other. Likewise, FX trading too has its own set of risks and could lead to substantial losses if you do not follow proper trade management. If you’re new to these markets and do not understand the underlying risk, here are some common odds and likely solutions that you should consider before jumping into forex trading.
Exchange rate risk
Exchange Rate, Volatility or Transaction Risk all mean the same and is the risk associated with a change in the value of exchange rates due to fundamental, technical, political or other factors, which could cause substantial shift in demand/ supply for one currency over the other. Unlike Exchange-traded markets where daily price limits are set by the Exchange, over-the-counter forex markets do not have daily price limits, thereby making them extremely risky. In addition to volatility, the low margin requirements to trade FX can result in hefty losses even on small price fluctuations.
Exchange Rate Risk can be managed by maintaining sufficient margins, position sizing, placing stops to minimise losses and following simple risk-reward practices.
JustForex provides suitable leverage to clients, starting from 1:1 up-to 1:3000
Credit risk
Also called transaction, counterparty or default risk, it is the likelihood that a forex broker or client defaults on payments to be made to the other. From the client’s end, the risk could arise due to the refusal by the broker to uphold trades due to market volatility, insolvency or plain default on confirming profits on certain transactions. Brokers on the other hand can also be subject to counterparty risk if a client defaults on payments due to losses on large leveraged positions leading to a negative account balance.
If your broker is registered with the financial services authority in the country of business, the chances of counterparty risk is very slim, since regulators ensure that the brokers are sufficiently funded. As a broker, Credit Risk can be mitigated by having stringent risk management systems in place that can safeguard client’s accounts from falling into negative balance.
JustForex is regulated by Belize International Financial Services Commission (license no. IFSC/60/241/TS/17). In addition, we compensate clients if losses exceed the funds available in their trading account.
Ex: If a client account falls into negative balance due to market volatility or any other reason, it will be set to zero and the negative balance written off.
Country risk
Country risk can occur due to large deficits in balance of payments, devaluation of a country’s currency, political uncertainty or default on sovereign debt. Country risk can lead to large scale selling of the currency, causing substantial volatility in the FX markets. Country risk is generally associated with developing countries and is relevant to the Asian Financial Crisis, the Argentinian Crisis and more recently, the Crisis in Turkey. Country risk can cause a currency to crash very quickly and traders holding opposite positions may not be able to exit in time owing to illiquidity in the currency which can eventually result in credit risk.
Country risk can be mitigated by trading in currencies with a stable outlook. Ex: G-7 currencies
Trading in the forex markets carries substantial risk due to leveraged positions and even though a trader’s view on the markets may be right, sudden market volatility due to the above risks can lead to large losses. However, maintaining sufficient capital, cutting losses when required and following disciplined trading practices can mitigate FX trading risk to a large extent.
So, when you ask, how risky is forex trading, take in the above points. There may be alternative ways to lessen the risk, like using AI, read some books on trading like ‘Trade Your Way to Financial Freedom‘ or using a broker with vast experience. Make sure you know what you are getting into and know that profits are possible, but so are losses.
