Online forex trading offers many lucrative opportunities to gain massive profits. However, where there are high returns, there are high risks too. Every trader needs to understand this well before entering into the forex trading market. There are many different risks that investors have to face during online forex trading. The four key risks that investors face are:
Exchange Rate Risk
The forex market worldwide undergoes a continuous balance shift of demand and supply. This is what gives rise to an exchange rate risk. A position is a result of all price alterations given that it stays outstanding. To prevent the chances of exchange rate risks, traders should trade within controllable limits. These limits are usually a bank policy function as well as the traders’ skills and field of expertise. The types of positions include overnight and daylight. The daylight position predetermines the highest amount of particular currency that an investor is permitted to stock at any one time within the day. An overnight position refers to any outstanding overnight position kept by traders. These limits help traders manage their risks and prevent losses.
Interest Rate Risk
These risks of foreign exchange trading are linked to forward out rights, futures, currency swaps and options in forex trading. These risks arise due to the gain or loss that is generated as a result of the forward spread fluctuations, mismatches in forward amount and the maturity gaps that occur among different dealings in the book of forex trading.
Traders can hedge this risk by employing interest rate based derivatives or by using swaps. The interest rate risk can be managed if traders invest in floating rate securities instead of fixed rate securities. Moreover, investing in securities with a short term maturity can also help in preventing interest rate risks. Another way of avoiding this risk is by purchasing interest rate derivatives.
These risks are linked with the likelihood that an unpaid currency position will not be repaid according to the agreement due to an involuntary or voluntary step taken by the other party involved. In cases like these, trading takes place on synchronized exchanges. Here, the learning house performs all the trade settlements. In these kinds of exchanges, all investors can deal exclusive of any concern of credit. In forex trading, two key credit risks are involved, the settlement risk and the replacement risk.
When a concerned party is not able to receive a probable payment due to interference by the government in insolvency matters of an institution or a bank, country risk occurs. The involvement of the government in forex markets is what causes forex trading risks. This risk is a joint duty of the credit department and the treasurer. The control of the government still remains on forex activities and is actively implemented. It is essential for investors to know how they may be capable of foreseeing any changes in restrictions concerned with the smooth currency flow.
It is important for investors to understand these risks. Having a deep understanding of them will enable them to prevent these risks while trading.