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14. Risks of Forex Trading

forex risks

Trading in the Forex market can be rewarding, but at the same time there are several risks attached. Traders must take note of the risks associated with the forex market and invest accordingly. In this article we will discuss 5 common risks traders face while trading forex.

‘Risk comes from not knowing what you are doing’
Warren Buffett

Margin or leverage risk

The most important risk factor traders must take into account while trading is high leverage and margin stop out. Good risk management is very crucial, especially if you’re responsible for trading decisions and managing accounts. If you opt for a high leverage such as 500:1 or 400:1, you need to understand that you're choosing to trade with high risk. If you open a trade of high volume and low balance and the market moves against you, there are greater chances of a margin call and losses.

Experts suggest that traders should not risk more than they can afford to lose. Experienced traders always manage leverage and required margin really well, they avoid excessive usage of leverage and never put at risk the maximum leveraged amount offered by brokers. Forex markets can be very volatile at times and excessive usage of leverage may result in heavy losses.

Volatility risk

As we all know, Forex markets can be unpredictable. The market can be very volatile and moves can be very large and unsuspecting at times which may come as a surprise to less experienced traders.

High volatility means massive swing moves which in turn could result in profits if you are on the right side of the market. However, it may also result in heavy losses if you are on the wrong side. Volatility is often taken in a positive sense by traders because they can take the advantage of good moves in the market. Having said that, proper risk management plays a key role during volatile times such as economic releases and political events to avoid heavy losses.

Political and economic risk

Currency pairs traded in the Forex market are tied with the respective countries and their economies. As countries can face political uncertainties there are always connected risks with associated currencies. One of the best examples is the Euro Zone, during times of elections in Greece and Grexit we saw heavy downsides in the Euro. Similarly, the Great British Pound declined sharply due to Brexit, political events like these can impact any currency to a greater extent and it’s hard to pre-empt. If traders keep check on important events and manage stop losses and margin properly, they can avoid losses during such crucial events.

As well as political risk, there is also economic risk. A few major risk events such as an interest rate decision in a country by their central bank, GDP data release, Non-Farm Payroll release in the US, Consumer price index and employment reports may impact the markets and respective currencies. At times there are important events on the weekend and since the markets are closed on the weekend, traders cannot make changes in their open positions. In such cases, there are chances of weekend gaps, which means the market opens either above the previous close or below the previous close.

There is a high risk associated if opening week gaps are large and may impact the open positions which are carried over the weekend, traders should always keep a check on important economic releases, forecasts and actual results to avoid any major shift in the market trend.

Intervention and currency devaluation risk

People can often ignore the power of central banks, the banks drive the markets and can make an impact with a market-shaking event or statement. One of the best examples is the SNB floor, for a long time the Swiss National Bank maintained a base rate of 1.20 in EUR/CHF, they bought heavily to keep exchange rates of the currency pair above 1.20. One day they decided to remove the floor which resulted in a more than 3000 pips decline in EUR/CHF within minutes.

black swan

Many traders lost a lot of money after the event which clearly points out the importance of intervention and currency devaluation by the central banks. Another example is the Japanese Yen, the Bank of Japan recently did all that they could to bring the exchange rate of the Japanese Yen lower, most JPY pairs like USD/JPY and EUR/JPY traded higher by a lot during the past 12 months.

Greed and fear

Trading in the forex markets can be very challenging at times, even good traders face tough times in managing their account and open position due to the risk of losing money. Fear can be one of the biggest enemies while trading and that’s why they say ‘never invest what you cannot afford to lose’. According to multiple surveys and opinion polls, many traders close an open position due to fear of losing money. They fear the risk associated with losing their initial deposit, it’s quite common to be scared but that’s where proper risk management comes in.

The risk of losing money due to greed can be a spoiler, many traders may keep losing trades open in ‘hope’ which ends up affecting their account’s equity. On the flip side, if you keep a winning position open in ‘greed’ and hope of higher gains, you can end up losing unrealised gains as well. Therefore, it’s always advisable to stick with your trading plan, goals and risk management to overcome fear and greed while trading in the forex market.