Forex, same as the foreign exchange, is the world’s largest financial market where more than 5 trillion USD is traded each day. A lot of investors want to start trading in the Forex market in order to generate substantial profits, however, they sometimes forget that this market also includes a big amount of risks. Those risks usually are related to potential capital losses and failures. There are several factors that cause most of the risks of trading Forex including unexpected market volatility, high level of leverage, interest rates, liquidity and credit risks. Those are the major factors that can influence a great deal of people’s trading processes and affect their overall payouts. Sometimes they can be very beneficial for investors, though if they are new in the market and don’t know how to use those tools appropriately, there is a high probability that they will end up losing all of their funds.
Therefore, the newcomers, as well as the professional traders, are recommended to attract close attention to the above-mentioned factors, find out every kind of information about them in order to avoid the bad consequences in the Forex market.
A lot of people believe the foreign exchange is a very easy market to trade with. Even though sometimes it might be true, there are various cases when this belief and false self-confidence become the major reason why they fail in their trading. This is why it is exceptionally important to have very realistic expectations as well as reasonable knowledge for protecting the initial capital.
In this article, we will further discuss the main risks of trading forex, highlight the most important factors and talk about the ways how people can avoid them in their future tradings.
The Risks of the FX Trading
As we have already mentioned, foreign exchange is the world’s largest financial market. Every person with an internet connection in their laptops can start buying the desired currencies and sell them anytime. Probably this easy access is one of the major reasons why the FX is so popular among the traders. Although, there are a lot of risks related to Forex, especially when it comes to losing money. We will further discuss down below the most essential factors that can be very dangerous to every investor while trading in the market.
The Forex Market Volatility
The volatility means a constant movement in the asset prices in any market. In many cases, this factor becomes the main reason why investors manage to gain substantial profits. They buy and assets at low prices and wait for them until their prices reach the high level and sell them only after that. This is how volatility can be extremely beneficial for some people. However, as we have already mentioned, this is one of the key reasons for fx trade risks and losing a big amount of money.
Forex volatility means that the market conditions and performance can change at any minute. So this is not surprising that it can go in the opposite direction so a trader might remain disappointed eventually. For example, if a trader buys an asset and after some period of time the asset price starts to reduce, even more, the trading results will not be beneficial for them so they will not be able to gain profits that way. What’s worse, if the price difference is very high, they will lose a big amount.
On top of that, the investors should also know that there are several situations when the market volatility reaches extremely high points. The factors that might have a huge impact on the volatility level include economic, financial, or political news as well as other types of sudden changes in the overall economic condition. In those cases, the risks of forex investing are getting higher than ever. For example, if the Non-farm Payroll report has just been released, there is a high probability that this data will have a huge influence on the current market performance. So in those cases, traders are recommended to avoid themselves opening positions and wait until the situation gets balanced. Otherwise, there will be a 50/50 risk on their trading, they will either manage to gain extremely big profits or they’ll gonna lose a very big amount of money.
High Level of Leverage
We all know that Forex is a highly leveraged market. It means that a lot of Forex brokers offer the investors the possibility to deposit a small amount of money in order to generate huge profits. The leverage ratio is always different and usually, it depends on each broker. The average ratio is considered to be 1:100 however, a lot of people trade with even bigger numbers such as 1:1000, 1:2000, or even more. The larger the ratio the bigger the chance of losing the initial capital.
It is not a coincidence that the leverage tool often is called a double-edged sword as it increases the Forex trading dangers as well as the potential amount of payouts. This is why it is extremely important to be very careful while using this trading instrument. In many cases, beginner traders have a wrong expectation about the leverage as they think this is the best way to benefit from their traders, so they start using a very high level of leverage. This is why they end up in unpleasant conditions. Therefore, the newcomers should remember that using leverage requires good knowledge of the market as well as skills and experience in order to avoid the risks related to this tool. Sometimes, even experienced traders fail, so losing money is a very common thing in the Forex market.
The Changes in the Interest Rates
The interest rates are also very essential factors in the foreign exchange market. It influences a great deal on the currency exchanges. It becomes especially important while talking about the risks. There can be a case when the interest rates might change unexpectedly and this is then the major risks of Forex trading takes place.
Let’s suppose the central bank unexpectedly decided to increase the interest rates. This will cause the specific currencies to strengthen, which means that their price will grow compared to the other currencies. All these things might happen immediately so the traders may not have prior information about this issue. This is why in most cases they tend to lose money because the market situation is against their needs.
Low Liquidity
Another noticeable feature is that the foreign exchange market usually a very liquid market because there always are people who want to buy and sell several assets. However, sometimes there can be a period when this liquidity reaches very low points because of several reasons such as weekends, holidays, and so on. In many cases, in a situation like this, the investors have to grow their spread sizes. This means that they will have less opportunity to generate a big number of profits. This is why the low liquidity is related to the risks of online forex trading.
Searching for the right broker
While talking about the foreign exchange market, it is very essential to mention the importance of searching for the appropriate broker to trade with. Probably this is the first and the most vital choice that a trader makes before starting to invest money. Each broker has different characteristics including various types of tools and different platforms for trading. This is why traders should be extremely careful with their eventual choice.
On top of that, the investors should never forget that there is always a probability of the liquidity provider may go bankrupt which means that they will no longer be able to pay for the profits the traders have generated. These are probably the main risk factors in FX trading related to the specific broker.
Also, another thing that everyone should take into account is the authorization of each broker. Forex regulations mean a lot especially when we talk about such large amounts of money. This is why every trader should take close attention to how trustworthy and reliable the broker is in order to avoid future failures and unwanted consequences in the forex market.
How to Mitigate the Dangers?
We all know that every trader’s biggest aim in the forex market is to gain as much profit as it is possible. However, reaching that aim might be very painful sometimes because in many cases, the road to success is full of mistakes. Though, there are several ways to avoid those mistakes while trading so let’s talk about those alternatives in a detailed way.
First of all, the most important thing about avoiding Forex trading dangers is using the demo accounts that almost every broker suggests. The main point about creating this type of account is that it gives the new and beginner traders an opportunity to experiment with the old strategies and exploring the new ones, practice trading in the specific platforms, and gain a lot of useful information about how the forex market works in general. Sometimes even professional traders use this way in order to prepare for their new trading. On top of that, the main beneficial thing about the demo account is that the investor does not have to put actual money at risk.
Another thing that needs to be mentioned about this issue is making the small trades in several markets instead of the single one. This will enable investors to avoid big failures in the Forex market, however, small traders will also not give them an opportunity to generate a substantial payout. In addition to that, another way to mitigate the risks of Forex trading is to use stop-loss orders that will help traders to avoid a big number of losses in the market. However, it requires specific knowledge and skills to know how to use this tool. If you are a newcomer and just decided to take the first step into the forex market, you are highly recommended to use the very low ratio of leverages, (not more than 1:50). This attitude will be the most beneficial for you as you will manage to control your potential risks in your future tradings.
The Bottom Line
In this guide, we have already talked about the main things related to the dangers in the foreign exchange market. As we have said, the major factors that cause risks are unexpected market volatility, high level of leverage, changes in interest rates, liquidity and credit risks, and so on. The new traders, as well as the professional ones, are recommended to attract very careful attention to the above-mentioned factors and find out every information related to them in order to avoid the bad consequences in their future trading.
Sometimes it is important to have realistic expectations as well as reasonable knowledge for protecting the initial capital. The main attitude towards this is to use low levels of leverages, especially when you don’t know properly how to use this too. Besides, another way of managing the risks of Forex investing is that, in case of volatile market conditions, investors are recommended to avoid opening positions and wait until the situation gets balanced. There are also other factors we have discussed in this article that needs to be considered attentively.
In terms of the risk mitigation process, the major thing is to trade with the demo accounts as well as to use the stop-loss orders to avoid potential losses in the market.