somrat4030
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Forex Trading Risk, Explain By Forex Forum
Is forex as risky as everyone thinks? One way to measure risk is to compare a financial product's risk relative to its return. If you take the time to compare an investment in forex to common investments such as equities and fixed income, you will find that from a risk/reward standpoint, forex investments provide respectable returns and should be considered viable portfolio diversification tools.
The spot forex market is unique to any other market in the world, as trading is available 24-hours a day. Somewhere around the world, a financial center is open for business, and banks and other institutions exchange currencies, every hour of the day and night with generally only minor gaps on the weekend. Essentially foreign exchange markets follow the sun around the world, giving traders the flexibility of determining their trading day.
So, Where's the Risk?
The reason retail forex trading is generally considered a high-risk investment is that its primary appeal is the ability to invest with margin. And a lot of margin at that!That's when your broker loans you money to invest in the forex market based on a small security deposit. Forex allows margins that are orders of magnitude that traditional banks and stockbrokers use and offer.
The consequence is that small moves in the currency are magnified and have a major impact on your funds. This means you can make quite a bit of money. But, you can also lose a comparable amount of money as well.
That makes it a high risk/high reward investment vehicle.
Understanding risk in FX trading
In FX trading on margin there are 2 major risk factors to consider:
1. Margin
FX traded on margin means you only need to deposit a small percentage of the overall value of the trade, known as margin. Therefore, with a smaller initial capital outlay you have exposure to a much larger position. This means that your gains could be multiplied if the market moves in your favour. Equally however, your losses could be magnified in exactly the same way if the market goes against you.
2. Volatility
Foreign exchange rates can change rapidly in response to any real-time economic and political events. This offers great opportunities for traders to make profits in the forex markets.
However, volatility can be a double-edged sword, and losses can accumulate just as quickly.
On the other hand, you need to know about currency risk.
Currency risk is also referred to as the exchange rate risk. Currency risk arises due to the variation in the price of one currency up against another. Companies and investors having a business operation or assets spread around the world are more likely to experience currency risk. This risk can go on to creating irregular losses or profits.
How does foreign currency risk work?
In broad terms, currency risk occurs when a company or investment relies on a foreign currency that must be translated into a domestic currency. For example, the U.S.-based Coca-Cola earns a lot of its sales across the world. So the company and its investors face the risk that its sales abroad may translate into lower sales in terms of U.S. dollars, if currencies fluctuate.
So here's how currency risk could play out if you're heavily exposed to one specific currency. For example, let's assume you're an American investor with a lot of money invested in Australia:
*. If the Australian dollar appreciates (relative to U.S. dollars), your Aussie investment is worth more U.S. dollars, all else equal.
*. If the Australian dollar depreciates (relative to U.S. dollars), your Aussie investment is worth fewer U.S. dollars, all else equal.
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Exchange Rate Risk
This relates to the appreciation or depreciation of one currency (for example, the USD) to another currency (base currency like INR). Every bank has a long or short position in a currency, depreciation (in case of long position) or appreciation (in case of short position), runs the risk of loss to the bank.
This risk mainly affects the businesses but it can also affect individual traders or investors who make investment exposure.
For example, if an Indian has a CD in the United States of America worth 1 million US Dollar and the exchange rate is 65 INR: 1 USD, then the Indian effectively has 6,50,00,000 INR in the CD. However, if the exchange rate changes significantly to 50 INR: 1 USD, then the Indian only has 5,00,00,000 INR in the CD, even though he still has 1 million dollars.
So, all things of this article are included with forex trading risk.
So, Risk Management is the Key
Which is why it's useful and practical to think of forex as a high-risk investment. That way, you're more aware of risks, and consider them in your trading decisions.
Many advanced, successful forex traders credit risk management as the primary reason that they can become professional traders.
The high-risk environment of Forex allows savvy FX traders to devise techniques and methods to reduce potential losses as a strategy to move the risk/reward ratio in their favor.
In the end, how much risk you want to take in Forex is up to you. The real danger is being tempted with thoughts of easy money to make trading decisions you shouldn't.
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