Just like how you cannot expect to gain something without enduring any pain, you cannot earn a reward without dealing with the risk and this applies to forex trading too. You surely have a chance to make profits by winning the trades that you place but you are also at the risk of losing your hard-earned money when the market does not move as per your calculations. But this risk does not be seen as an obstacle in your trading journey as the risk of forex trading comes from the volatile nature of currency and this volatility also offers profitable trading opportunities that you can thrive on.
It all comes down to your ability to manage the risk and reap the rewards by trading with a cautious approach. In this blog, you will learn about different types of risks in forex trading and how you can manage them to get the desired results.
Types of Risks in Forex Trading
- Currency Risk – Currency risk is the risk of unfavourable fluctuations in the exchange rate of currencies which can affect your profitability in forex trading. The value of currencies can change due to the influence of various macroeconomic and microeconomic factors. This will affect the conversion rates of currencies and since you will be trading with different currency pairs, the currency risk can have a huge impact on your trading account and results.
- Leverage Risk – Forex traders often use high leverage for amplifying their potential profits but excess leverage can wipe out all your capital as the potential losses will also be multiplied leading to a bigger account drawdown. The risk of a margin shortfall is also there and hence you need to estimate the margin level (amount of funds needed in your account to keep a trade open) based on your trade size and leverage. You can use a margin calculator for accurate results.
- Liquidity Risk – A trader needs enough liquidity for entering and exiting trade positions without any difference in the price at which buy and sell orders are priced. When the market is inactive, the trading volume will be low and there will not be sufficient liquidity when the number of buyers and sellers is less. This can lead to issues like price re-quotes and slippage.
How to manage the risks?
Now you know about the various risks that make the trading process challenging. But the risk also depends on the currency pairs that you choose for trading as well as your trading style and strategy. For instance, trading with exotic pairs is the riskiest due to the low liquidity and extreme volatility. Cross pairs are less risky in comparison, as they are more liquid and not as volatile as exotic pairs. Most beginners are told to trade with major pairs at first as they are safest due to the high liquidity. The spreads of major pairs are also tight which allows you to minimise the cost of trading.
The trading style and strategy that you want to follow are equally important for assessing the level of risk you are taking. Trading styles like scalping and day trading do not involve any overnight risk as the trades will be opened and closed on the very same day. But you will be entering multiple trades to make small profits by trading with shorter timeframes and this can result in higher risk if you are not skilled enough to make sound trading decisions. You need to master technical analysis to attain success with these intense trading styles.
Another thing to consider for managing the risk is the trading session that you find suitable for trading. The volatility and trading volume will be different during different trading sessions and you must plan your trades after taking this into account. The extent to which prices can move can be estimated by using tools like volatility indicators and since the price movements are measured in pips, you can use a pip calculator for setting your target profit by counting the pips you want to earn from a trade. Find out more on how to calculate the pips in the base currency of your account.
The first thing you have to do to manage the risk is devise a sound trading plan and stick to your strategy with a disciplined approach. Apart from this, there are some simple things that you need to do to keep the risk under control.
- Use stop-loss
One tool that you need to use for managing the risk is a stop-loss order. When you find a trading opportunity, you will proceed with the trade when you think the trade has a high probability of winning. But the probability of losing is also there if the market becomes unfavourable. However, when you place a stop loss at the right place, the loss can be minimised.
The trade will be closed once the specified price is reached and this way the stop loss will help you to cut the losses early even if you are unable to exit the trade manually. This is perfect for managing the trade positions when you can’t monitor the price movements by yourself.
- Choose a reliable broker
The broker that you sign up with for trading is in charge of connecting you to the decentralised forex market. The trading conditions that the broker offers need to be considered before opening your trading account with them. Having favourable trading conditions along with a technology-driven trading platform is essential to carrying out the trading process with ease. You need to make sure that the broker offers a seamless trading experience with fast execution of orders.
You need to test their platforms by opening a demo account first and then test your strategies to check if the broker will be the best one for you. You should also check out the trading tools they offer and most brokers and trading platforms offer free forex calculators that provide instant results for all trade-related calculations. Trading with a regulated and reputed broker is important for a secure trading experience.
- Hold the leverage low
In the beginning, I explained about leverage risk and that you need to reduce this risk by holding the leverage low. Forex brokers will often offer high leverage to their clients but you should only use limited leverage to avoid huge losses. You don’t have to avoid leverage completely as it allows you to open bigger-sized trades with a low margin requirement and you can use it for growing your trading account.
But at the same time, you need to be careful and ensure that the leverage ratio is in line with your risk tolerance. If you don’t pay attention to risk management, the excess leverage can blow up your trading account. So, never risk more than what you cannot afford to lose even when you are trading with leverage.
Conclusion
In the end, understanding different types of risks and taking some measures to deal with them is essential to ensure trading success. You need to consider different possibilities before placing a trade and prepare for the worst-case scenario. This is the essence of risk management as you have to protect your trading capital before trying to make profits.
