The forex market is also called the foreign exchange market. Whatever you call it, it’s something that facilitates buying and selling the many currencies of the world.
As with stocks, the purpose of forex trading is yielding a net profit from buying low so you can sell high, while at the same time minimising forex trading risk.
Forex traders have an advantage over stock
Forex assets are usually categorized as highly liquid assets given the high trading volume, and most forex trades consist of forwards, foreign exchange swaps, options, currency swaps, and spot transactions.
On the other hand, while there is plenty of money to be made in this market, it’s not a sure thing. Since it’s a leveraged product, the dangers of forex trading can mean significant losses.
Keep reading to learn about the common ones to watch out for.
In a financial transaction, the counterparty is whoever is providing the investor assets, which means that counterparty risk means the broker or dealer of a certain transaction. There are no clearing houses or exchanges guaranteeing spot and forward contracts in forex currency trades, so under volatile conditions, some contracts might be refused or just ignored.
When choosing which options to invest
Many third-world or developing nations fix their exchange rates to a global leader, like the American dollar. In such cases, central banks must keep enough reserves that they can maintain the fixed exchange rate. Frequent balancing of payment deficits can devalue a currency and create a currency crisis.
Currency Value Fluctuations
Currency values change fast sometimes, and quite a few reasons can be the culprit. It could be external economic and political news, or just market changes. Fluctuations aren’t evil by themselves, but when currency values spike or fall really quickly, traders might not be able to keep pace or forecast properly.
Interest Rate Risks
Something else that can swing forex prices dramatically is interest rates. When the interest rates of a nation go up, its currency rises, while falling interest rates weaken a currency.
Forex trading involves leveraging, which needs an initial but small investment known as a margin to get into play. Sometimes, the amount needed goes up, and using it aggressively can risk serious losses.
This risk happens when the counterparties of a failed Forex broker or bank discover that they’re possibly not going to receive their funds due to them from the failed establishment or party.
Risk of Ruin
Being unable to sustain positions, bear unrealized short-term losses, or failing to meet margin calls, even in a good long-term strategy, can mean losing everything.
This risk happens because of the various time zones across the continents. Currencies are thus traded not only at different hours, but different prices. The dollars of Australia and New Zealand get credited first, followed by the Yen, before moving to European currencies, and then setting with the American dollar. It’s possible that payments to parties might be declared insolvent before that party even executes its own payments.
Unforeseen losses might happen due to communication errors, or even mistakes in the handling and confirmation of trader orders, sometimes known as ‘out trades’. In many cases, even when out trades are definitely the fault of a dealing counterparty establishment, the trader might have limited recourse in getting any compensation for the losses they suffered in their account.
How To Be Successful
There will always be dangers of forex trading, but there are also ways you can minimize or manage your risk. The traders that only do a few but big concentrated trades are the ones most likely to lose money. Aggressive leveraging also risks more loss. Distribution of trading funds over many trades diversifies risk and increases the odds of profitable trading.
The dangers of forex trading are real. Over two-thirds of forex traders report losing money in each quarter of the previous year. Many retail forex traders actually drop out within just four months.
Start your trading using a practice account to master safe strategies. Limit potential losses with stop-loss orders. Be careful with using any available leverage until you really know how to do it right.
As mentioned, diversify your risk. The biggest and the best thing you can do is to keep learning with a conservative perspective to keep up with a constantly changing market and avoid the dangers of forex trading.