Forex Trading Risks And Ways To Avoid Them
Why does a trader take risks when trading forex or cryptocurrencies?
Forex trading or Forex trading means dealing with the process as a commodity to be bought and sold and this is done through brokerage firms that facilitate the buying and selling of foreign currency around the world and through various means of communication or what is known as OTC -System. As with trading stocks, the main goal of Forex trading is to make a profit by buying currencies at a low price and selling them at a higher price. Comparing the forex market and stocks, we find that forex traders should only focus on a relatively small number of currencies as opposed to trading on the stock exchange which has to analyze hundreds of companies and sectors and choose the best investment opportunities among them .
And you need to take into account that every investment has its own risks; Forex trading, like other investments, despite its various advantages, carries some risks, some of which can become risky if misused.
The foreign exchange market is a highly liquid asset and the majority of foreign exchange trading deals include spot trades, futures contracts, and options contracts. The foreign exchange market is characterized by the presence of what is known as financial leverage, which can become one of the most important risks in forex trading.
Also, unlike the stock market, the Forex market is a decentralized market, and this is considered to be one of the most outstanding advantages of Forex trading as the lack of a centralized market makes trading easier and faster for a person or specific entity to control, but this feature can too risk as any risk in the forex market can outperform any individual, company or entire sector. However, if you understand the types of forex risks and carefully trade with a trading mechanism and strategy, you can trade effectively.
What are the risks involved in forex trading?
Leverage Risk and Margin System
As mentioned earlier, one of the advantages of the Forex market is financial leverage. First of all, it is important to briefly explain what financial leverage is. Leverage simply means giving small investors the ability to trade large amounts of money by trading their relatively small accounts. Since the foreign exchange market, or trading, was originally restricted to large investors and owners of huge accounts, brokerage firms sought to give small retailers access to the foreign exchange market.
Leverage allows small investors to trade forex at multiple times their own capital, and the brokerage company’s facilities can offer leverage in excess of 1000 times the original capital.
In forex trading, leverage works with a system called the Margin System, which reserves a small portion of the capital to enable large trades to be executed and acceptable profits to be made. Fluctuations in the markets can force the trader to pay an additional margin. During volatile market conditions, the forcible use of leverage results in large losses that can exceed the initial investment or capital, hence we say that leverage is a double-edged sword as a larger deal is also closed and the profits made from the deal are increased the amount of losses, or in other words leverage, is a reinforcement tool that increases the outcome of the transaction, whatever it is.
There are many traders in the forex market who rely on opening more than one forex trade at a time without having a maximum loss in their trades until they end up making big profits. In this case, the risks of financial leverage are greatly increased because, as mentioned earlier, the loss may exceed the amount of the transaction and possibly, with its aggravation, exceed the original capital explained in the next paragraphs.
Interest rate and exchange rate risks
In foreign exchange trading, traders in the foreign exchange market convert one country’s currency to buy another country’s currency or sell one currency to buy another, and changes in the relative value of a currency can result in gains or losses.
When you buy or sell currencies in the foreign exchange market, you are betting that the exchange rate of the currencies of the two countries will change against each other. If all other factors are constant and equal, you will when you buy one currency and its value against the other currency, you make a profit, but when the currency’s value goes down, you will make more losses.
It should be noted that the exchange rate is closely related to each country’s interest rate, so higher interest rates tend to attract more investment in the country and its currency.
In other words, the high interest rates of lenders in the economy offer a higher rate of return compared to other low interest countries. Hence, higher interest rates attract foreign capital and lead to an increase in the exchange rate.
Hence, anyone who trades in the foreign exchange market or forex needs to be mindful of this relationship before starting any business, plan to manage the business and also before exiting the business and this will surely come with time by looking at global developments , Learn forex trading and know important and influential dates about the currency, which is the economic calendar.