In the previous lessons, we reviewed many topics related to trading in the foreign exchange market, and the most important advantages of forex trading, and in this lesson we review some of the risks of forex trading and some techniques to overcome those risks
Why are there risks in forex trading or forex trading?
Foreign exchange trading or forex trading means dealing with the process as a commodity to be bought and sold, and this is done through brokerage companies that facilitate the process of buying and selling foreign currencies around the world and through various means of communication or what is known as the OTC system. Like stock trading, the primary objective of forex trading is to make profits by buying currencies at a low price and selling them at a higher price. By comparing the currency market and stocks, we find that forex traders have to focus only on a relatively small number of currencies unlike trading in the stock market, which needs to analyze hundreds of companies and sectors and choose the best investment opportunities among them.
And you must take into account that each investment has its own risks, forex trading, like other investments, involves some risks despite the various advantages that it enjoys, some of which may turn into risks if it is misused.
The currency market is a highly liquid asset, and the majority of forex trading operations include spot transactions, forward contracts and option contracts. The foreign exchange market is characterized by the presence of what is known as financial leverage, which may become one of the most important forex trading risks.
Also, the foreign exchange market is a decentralized market unlike the stock market, and this is considered one of the most prominent advantages of forex trading because the absence of a central market makes trading easier and faster and difficult for a person or a particular entity to control, but this feature may also become a risk because any risks in The currency market may outperform the performance of individuals, companies, or entire sectors. However, if you understand the types of forex risks and trade carefully with a trading mechanism and strategy in place, you can trade effectively.
What are the risks of trading in forex?
Leverage Risk and Margin System
As we mentioned, financial leverage is one of the advantages of the foreign exchange market. First, it is necessary to explain what financial leverage is in a nutshell. Leverage simply means giving small investors the opportunity to trade large amounts of money by trading their accounts that are small in comparison. Since the currency market or forex trading was initially restricted to large investors and large account holders, brokerage firms tried to provide facilities for small individual traders to enter the foreign exchange market.
The leverage allows small investors to trade forex with several times the size of their own capital, and the brokerage firm's facilities may be to offer leverages exceeding 1000 times the size of the original capital.
In forex trading, the leverage operates with a system called the margin system, which is by reserving a small portion of the capital to allow the execution of large trades and make acceptable gains. Fluctuations in the markets can force the trader to pay extra margin. During volatile market conditions, the violent use of leverage will lead to large losses that may exceed the initial investment or capital, so we say that leverage is a double-edged sword because entering a larger deal and increasing the amount of profits resulting from the deal, also increases the size of the losses, or In other words, leverage is an amplification tool, which increases the outcome of the transaction, whatever it is.
There are a lot of traders in the currency market who depend on opening more than one forex trade at the same time without there being a maximum loss in their trades until they achieve big profits in the end. In this case, the risks of financial leverage occur significantly, because as we mentioned, the loss may be greater than the size of the transaction amount and perhaps with its aggravation it may reach more than the original capital. Therefore, please be careful in dealing with transactions and financial leverage during market fluctuations using several techniques that will be clarified in next paragraphs.
Interest rate and exchange rate risks
Forex trading involves traders in the currency market exchanging one country's currency to buy another country's currency, or sell one currency for buying another, and changes in the relative value of a currency can result in profits or losses.
When you buy or sell currencies in the forex market, you are betting that the exchange value of the two countries' currencies will change against each other. If all other factors are constant and equal, if you buy a currency and it ends up increasing in value against the other currency, you will make profits, but if the value of the currency decreases, it will cause you more losses.
It should be noted that the exchange rate is closely related to the interest rate of each country, so higher interest rates tend to attract more investment in the country and its currency. On the contrary, low interest rates will lead to the withdrawal of investment, which will weaken the country's currency and reduce its value.
In other words, the high interest rates of the lenders in the economy provide a higher return compared to other countries with low interest rates. Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise. And the exact opposite happens when interest rates are lowered, that is, a lower interest rate leads to lower exchange rates.
Thus, whoever trades in the foreign exchange market, or forex, must pay attention to this relationship before starting any deal, plan to manage the deal, and before exiting the deal as well, and that certainly comes with the passage of time by following global developments, learning forex trading and knowing important and influential data The Arab Trader website provides one of the best and most professional tools in the Arabic language to follow up on all data and events affecting the major currencies and a measure of the degree of their impact on the currency, which is the economic calendar.
Geopolitical risks - international
If you have decided to enter the foreign exchange market, you must make a general assessment of the economic and political situation of the country that owns the currency in which you intend to invest, especially at that point, we can divide the aspects of risk into two main categories
The first category, which is the direct and clear category, it is possible for the instability in a country to affect the currency of that country, when any negative event occurs, and traders are concerned about the possibility of a bad event, traders often transfer their money away from the currency of that country, and this This is considered a kind of risk aversion, thus starting a selling wave on the currency, which leads to its devaluation.
This was noticeable during the period that witnessed talks between the European Union and Britain between 2015-2020 on reaching a trade agreement after Britain's exit from the European Union bloc. And the higher the expectations that the two parties would not reach an agreement, the greater the pressure on the pound sterling, and it recorded a decline, for fear of achieving the scenario of Britain’s exit from the European Union without an agreement, which would weaken the British economy and thus weaken the pound sterling, the currency of the United Kingdom.
And you, as a forex trader, do not want to be on the wrong side of a trade when the value of a currency goes down. It is also possible that political turmoil in a country affects the market in that country, so you may find yourself stuck in the deal and record more losses. As we mentioned earlier, learning to trade requires continuous follow-up of global developments and political news, and this opportunity will be available by following up on continuous coverage of foreign exchange market developments and forex news through the Arab Trader's website.
The second category appears when a country deliberately devalues its currency, and some traders in the currency market call this devaluation or currency devaluation. It should be noted that the state's goal when taking such a measure is not bad in itself. It is just one of the monetary policy tools in this country, where the state intentionally devalues its currency to give it an opportunity to compete more effectively with regard to the commercial aspect; The lowest price currency makes the country’s exports less expensive, because the goods it exports are then at a cheaper price in the global market and thus achieve a greater return than its exports, which increase with the demand of importers
Operational risk or counterparty risk
The counterparty in trading or in any financial transaction is the companies or individuals that provide assets to the investor or execute his transaction, through which transactions are initiated. Thus, the risks of operations or the risks of the counterparty are the failure or failure of the counterparty to fulfill the commitment entered into, whether in the implementation or liquidation of the transaction.
To understand the matter more clearly, we say here that the other party to your deal when trading forex is the brokerage company, through which you or through the trading platform that you provide to implement trading orders in the market, your poor choice of the company or broker may cause direct risks to your trades in In the event that the company does not implement your deals or fails in the execution process at the prices that you set in opening or closing those deals, and sometimes the problem reaches the possibility of withdrawing your profits from the company in the event that the implementation process goes smoothly without problems, so there are important considerations when choosing a brokerage company To ensure that no manipulation occurs that harms your interests while trading