The foreign exchange market facilitates the buying and selling of currencies around the world. Like the end goal of forex trading is to yield a net profit by buying low and selling high. Traders have the advantages of choosing a handful of currencies over stock traders who must parse thousands of companies and sectors. In Trading volume, the forex market is largest in the world. Due to high trading volume, forex assets are classified as highly liquid assets. The majority of the foreign exchange trades consist of spot transactions, forwards, currency swaps, foreign exchange swaps, and options. However, as s leveraged product there is plenty of risks associated with forex traders that can result in substantial losses.
5 Forex Risks Traders
In forex trading, leverage requires a little initial investment, called a margin, to gain access to substantial trades in the foreign currencies. Small price fluctuations can result in the margin calls where an investor is required to pay an extra margin. During the volatile market conditions, aggressive use of leverage will result in substantial losses over initial investments.
2.Interest Rate Risks
If a country’s interest rates rise, its currency strengthens due to an influx of investments in country assets putatively because a stronger currency provides the higher returns. Conversely, if interest rates fall, its currency weaken as investors begin to withdraw their investments. Due to the nature of the interest rate and its indirect effect on exchange rates, the differential between the currency values can cause forex prices to change dramatically.
Transaction risks are an exchange rate risk associated with the time differences between the beginning of a contract and when it settles. Forex trading occurs on a 24-hour basis which can result in exchange rates changing before trades have settled. Consequently, currencies may be traded at different prices and at different times during the trading hours. The greater the time differential between in entering and settling a contract raises the transaction risk. Any time differences allow in exchange risks to fluctuate, individuals and corporation dealing in the currencies face increased, and perhaps excessive, transaction costs.
The Counterparty in a financial transaction is a company which provides an asset to the investor. Thus counterparty risk refers to the risk of default from the broker or dealer in an individual transaction. In forex trades, spot and forward contracts on the currencies are not guaranteed by an exchange or clearinghouse. In spot currency trading, the counterparty risk comes from the solvency of market maker.During the volatile market conditions, a counterparty may be unable or refuse to adhere to contracts.
When weighing the options to invest in the currencies, one must assess the stability and structure of their issuing country. In many developing and third world countries, exchange rates are fixed to a world leader such as the US dollar. In the circumstance, central banks must sustain adequate reserves to maintain a fixed exchange rate. Currency crisis can occur due to the daily balance of payment deficits and result in the devaluation of the currency. It can have substantial effects on forex trading and prices.