Top Forex Trading Risk to Avoid

When it comes to liquidity and trading volume, the forex market is the largest in the entire world. Most of the forex transactions are based on forwards, options, forex swaps, spot transactions, and currency swaps. All these products and instruments are leveraged. Leverage is a double-edged sword. Yes, leverage gives you the power to open a large trading position with a small amount of capital, but at the same time, if the trade goes against you, you lose your initial capital and the leveraged money with the loss incurred on the trade. 

There are various risks associated with the forex trade, and leverage risks just one of them. In this article, we will talk about the top forex risks that every trader must consider. 

Leverage Risk

When you trade currency pairs via leveraged products, you need to put in some minimal initial investment called margin. Margin is the way to access significant trades in various currency pairs. Due to small changes in the price, margin calls take place. Margin calls require traders to pay an additional margin. During high volatility, excessive leverage can also result in extensive losses due to an excess of the initial investments. Therefore, it is very crucial that traders use leverage with utter caution and measurement. Many new traders think that leverage is a free pass to rapid and expansive profits. Well, this isn't quite the case. Leverage surely gives you the opportunity to open large trading positions, but if these positions do not work in your favor, you end up losing your margin, i.e., your initial capital, your leveraged money, with the loss you incurred on the trading position. Therefore, leverage trading is considered one of the major forex risks for traders. 

Interest Rate Risk

Another in the list of major forex risks is fluctuations in interest rates. When any institution borrows money, the lender will charge an interest rate on the loan. The rate of interest typically depends on how much risk the lender is taking. The borrowers that are considered highly risky will pay a high rate of interest on the loan. On the other hand, borrowers that entail lesser risks pay lower interest rates. 

Setting the financial policies within various countries is the job of central banks to ensure stability and growth in the economy. The fluctuations in the rate of interest influence the decisions of the traders. 

One must understand that the exchange rate and the interest rate work hand in hand in any economy. Therefore, it is crucial to pay diligent attention to interest rate fluctuations. This way, you will be able to decipher where the large businesses and institutions are investing their securities to receive the highest returns. 

Transaction Risk

Another in the list of top forex risks is the risks pertaining to transactions. These are the exchange rate risks concerning the differences between the starting and closing of the contract. In forex trading, the exchange rates might change even before the settlement of the contract as the forex market goes live for 24 hours a day. Higher the gap between the start and end of the contract, the higher the transactional risks. 

The reason is that the time differences facilitate the fluctuations in the exchange rates. Thus, individual traders, institutions, and trading corporations face high transactional costs. 

Volatility Risk

One of the major forex risks is volatility risk. One can describe volatility risk as the number of changes or fluctuations that take place in the market. Even though volatility in the market is seen as a risky element, it also has some positive influences. Without volatility in place, it would be impossible to trade currencies via the high liquidity of the market. Therefore, trading in balanced volatility in the forex market can aid in substantial gains. On the other hand, extremely high volatility that hits the market when some big change or announcement takes place can be immensely dangerous for forex traders and investors. 

Broker Risk

Another in the list of top forex risks is the risk associated with the forex broker or financial service provider. It is very important that traders pursue diligent research before putting in their hard-earned money with any broker in the trading world. If one goes with a wrong forex broker involved in fraudulent activities, one can end up losing all the capital and profits. Therefore, it is crucial to pursue trade with a regulated and reputable broker. 

If you are looking for a financial broker to pursue forex or any other trade, we recommend HFTrading. HFTrading is a highly regulated broker offering trade in an expansive range of instruments like currency pairs, commodities, metals, stocks, indices, ETFs, CFDs, and more. 

Counterparty Risk 

A counterparty is any company in a foreign exchange transaction that renders the asset to the trader. Counterparty risk entails the risk from the broker or financial service provider, or dealer involved in a particular transaction. If we talk about forex trading, the forward and spot contracts are not guaranteed by any exchange. In spot trading the currencies, the risk is present in the solvency of the maker of the market. During sheer volatility, the counterparty might refuse to adhere to the contract. 

Devaluation Risk

In the list of top forex risks lastly, we will shed some light on devaluation risk. Devaluation occurs when a country alters its currency downward as compared to another country's currency in utter deliberation. 

Devaluation is a financial policy tool used by countries that have a fixed exchange rate. The government determines devaluation due to the impact of currency price on the activity of the government. One of the main reasons why the government devalues its currency is to stop the imbalances in trades. Devaluation of currency results in a reduction in exports of the country, making them less expensive and more competitive in the international markets. 

So when devaluation occurs, interest rates are hiked up to keep inflation in control. Devaluation can be seen as a sign of weak economic conditions in a country that dismantles the creditworthiness of a country. Sometimes, devaluation is a result of utter competition in which countries devalue their currencies in response to the devaluation of neighboring country's currency. This leads to global issues in the markets. Therefore, you must put utter consideration into the countries that are devaluing their currencies. 

Conclusion 

With this rather long list of forex risks, the losses in the forex market may be higher during the initial times. Due to high leverages operating in the market, a small initial fee can lead to huge losses due to illiquid assets. Moreover, the time differences and political risks associated with the forex market can have lasting impacts on various currencies. Yes, the forex market has the highest trading volume, but the risks are high too.