From an economic point of view, risk is a certain probability of loss or non-profit instead of the expected result. Entering the Forex market, many “newly-minted” traders expect to receive huge and, most importantly, quick profits and do not at all think about the considerable risks that await them in the market.
In order to learn how to avoid mistakes and trade profitably, you need to consider the main risks of Forex market. Any trade is based on the purchase and sale of a product or service. In the Forex market, commodity is currency.
In fact, this is an exchange of currency, from one to another, to make profit due to the difference in price on the principle of buying cheaper, selling more expensive. In a nutshell, we buy the currency, wait until its rate rises sufficiently, sell it - and here it is - the long-awaited profit.
In reality, a change in the exchange rate is made every second, therefore, to achieve profit, all transactions (purchases / sales) should be made as soon as possible.
It turns out that, on the one hand, rate variation is the basis for revenue, and on the other hand it represents a serious risk of losing the entire deposit.
No one is safe from changing the exchange rate in a disadvantageous direction, which will be the culprit of losses arising from operations on Forex.
The stability of the exchange rate is influenced by a large number of factors, some of which are not amenable to any forecasts.
In order to avoid or at least minimize the risk of losing the deposit when the trend moves against you (i.e., when the exchange rate is negative for you), strict observance of several principles is recommended:
- Before opening a position, make a preliminary thorough assessment of the behavior of exchange rates;
- Enter the transaction exclusively according to the trend. At the same time, do not limit yourself to the trend direction on your chosen timeframe, but also take into account the trend at adjacent time intervals;
- Immediately establish a Stop Order (Stop Loss) after opening positions, this will allow you to proactively limit the possible amount of loss;
Summarizing the above: if you can correctly determine the direction of price movement and set Stop Loss in order to protect yourself from the reverse trend movement, the risk of a change in the exchange rate can be significantly reduced.
Leverage Choice Risk
To begin with, let’s recall that leverage refers to funds borrowed by a trader from a brokerage company. The amount of leverage varies from 10 to 1000.
Leverage is not the usual loan that we are used to understand it. The loan granted by a broker increases the amount of the deposit, while it is not credited to the account of the trader, that is, the funds are immediately transferred to the transaction, allowing you to operate with larger volumes.
For example, a leverage of 1:100 indicates that the loan issued is 100 times the deposit of the trader.
- If a trader’s deposit is $1000, using a leverage of 1:10, the trader will be able to carry out transactions for $10000 (his own funds - a thousand dollars, remain pledged to the broker)
- If profit is made, the broker deducts the loan amount, leaving everything else to the trader.
- If the transaction is unprofitable, the broker will also not remain in the loss. It will also deduct and take back the borrowed funds, reimbursing the shortage from the deposit of the trader.
In the external attractiveness of the amount of leverage its main risk hides.
The amount of leverage is chosen by the trader himself, and is limited by the policies of each broker. All client transactions are constantly monitored by the broker and are automatically closed when the amount of loss and collateral are equal.
Conscientious companies interested in profitable trading of their clients set a certain critical level (Stop Out) of loss (a certain percentage of the amount of the pledge), upon reaching which the transaction will be closed automatically. In this case, the trader will not lose his entire deposit, due to the remaining positive balance in the account trading can continue.
Leverage of 1:500 and 1:1000 contribute to the opening of positions even greater trading volume. On the one hand, with proper use of the strategy and understanding the risks, you can significantly increase profits, but on the other hand, when you open a transaction with a maximum lot, you can very quickly lose all your funds.
To overcome leverage risk, use the following recommendations:
- choose a proportionate leverage;
- carry out insurance against losses;
- take risks only with complete confidence in the direction of the trend.
General technical risks
You can talk about global trends, market conditions, trend reversals, etc for a long time, but simple and ordinary situations can make trouble to a trader. They are called technical risks. There are a lot of them:
- Sudden power outage. As a result, the computer, along with the trading terminal, stop, communication with the broker server is lost.
In this situation, uninterruptible power supplies will help, which will provide some time to close the position, as well as a phone by which you can contact the broker (the main thing is to remember or write down its phone number). By the way, as you know, laptops do not experience such problems.
- Internet connection break. If you have a dedicated wire line, you can advise having an auxiliary Internet source, for example, through a modem or phone.
- Software failure (operating system or trading terminal).
As a solution to the problem, we recommend installing backup software (on another computer, iPhone, or other suitable device).
We overviewed only a few possible options and want to say that the best method of reducing technical risks is timely setting the Stop Loss, this will save you both money and nerves.
When concluding an agreement with a broker, some newcomers do not even suspect that they often deal with an intermediary company that itself does not trade in the Forex market, but accepts money from customers and, in turn, enters into an agreement with a real broker. Only some brokerage companies work on Forex on their own.
A rash choice of a broker can lead to various problems:
- an unscrupulous intermediary simply disappears with the client’s money, or a “dishonest broker” invests funds at his discretion in problematic projects instead of real trading;
- fuzzy work, as a result of which the execution of orders is delayed, and the opening of the position will occur in the wrong place at all.
In order not to get into trouble before starting work, do not be too lazy to learn more about the broker you have chosen, how it works, whether it has the appropriate licenses, and it will not be superfluous to get acquainted with real clients’ reviews.
Credible brokers do have positive reviews, surely more than one, act professionally with instant execution of orders. In addition, they can offer a training course and lerning materials.
Trading in any market is often stressful: anxiety and depression, panic often reaching despair. The cause of the panic can be a rapidly changing market situation, which, in turn, depends on both internal and external circumstances.
External factors that influence the market undoubtedly include political and financial news, information about the economic situation in different countries, which currency is involved in Forex trading, and so on. Depending on the nature of the information, the exchange rate of the national currency changes: increase or decrease.
Internal factors include the activities of the largest market participants - national banks of developed countries. By selling and buying large volumes of currency, they influence the change in the exchange rate. A sharp increase in demand for any currency will immediately cause an increase in the exchange rate, and vice versa, the supply of large amounts of currency will lead to a drop in the exchange rate.
Since there are always a huge number of participants on the Forex market and many of them are subject to panic, they rush to close deals seeing a sharp deviation in the exchange rate, provoking further reducing the price of the asset they’ve been trading.
The market reacts sharply to all these factors making it fluctuate more actively. Moreover, sometimes such actions are provoked only by rumors.
Do everything possible to control your own emotions, not giving them the right to manage the trading process. To eliminate or significantly reduce the risk of panic, you need to build your own Forex behavior system, which you must follow:
- Focus on what you are going to do;
- Trade on the basis of informed decisions, not giving vent to emotions;
- Thoroughly study and analyze the causes of trend movement in current and previous periods;
- Open transactions only on the basis of verified information;
- Use Stop Loss and Trailing Stop as insurance tools when opening a position.
There are still risks that cannot be ignored. First of all, these are global natural disasters, resignations of governments and so on.
Forex risks include some actions of governments and central banks, which result in administrative barriers that impede the market. It is impossible to foresee these risks, but, nevertheless, they cannot be completely ignored.
Specialists recommend that you constantly monitor the situation on the market and do not neglect the protection of your positions, which will help you to get prepared for the possible force majeure.
Forex Risk Management
It is known that you must follow a strategy to reduce potential losses for successful trading.
Risk Management Forex, a system that is inherently simple, consists of several basic rules for minimizing risks.
Tips to keep in mind:
- Open new positions only if you understand the situation on Forex;
- Be aware of what financial risks may occur at any time;
- Create your own trading method; make sure it’s optimal and profitable;
- Set the limit of loss that you can allow, and upon reaching this limiting amount, immediately exit the game;
- Carry out trade in the direction of the trend, actions against the trend are much more risky;
- Application of optimal leverage. An unreasonably high leverage will create the risk of losing everything with the smallest movement of the trend.
- Set Stop Loss immediately after the start of trading;
- Close positions immediately if the price goes against you;
- Deal only with reliable brokers;
- Use uninterrupted power supplies, a backup connection to the Internet and other means of communication;
- Do not lose control over your emotions, do not succumb to panic and do not commit impulsive actions;
- Leave the market Without delay, if you don’t understand or doubt how to act.
Author: Kate Solano for Forex-Ratings.com