Foreign Exchange Risk Management Methods
Veteran and amateur traders alike must understand forex risk management methods if they hope to have any chance of financial success in the long run.
Most traders, if they think of risk at all, only think about market risk. That is how changes in the value of the currency we are trading affect our funds. However there are 5 major types of risk when trading forex and it’s important you understand each of them.
Listed below are the 5 major risks all FX traders must be aware of, and simple strategies to protect yourself from each of them.
While some traders may be scared off when they see the true risks involved in forex, seasoned traders realize that being aware of the risks is the first step in eliminating them. You should look at this list not as something that turns you off trading, but simply as a tool in your arsenal to put you one step ahead of the competition.
The Five Different Types of Risk When Trading Forex
#1. Broker Risk: There is always a small chance that your broker will go bankrupt or otherwise meet their demise.
As you might remember, in 2005 Refco went bankrupt and they were one of the world’s largest investment and brokerage firms involved in forex.
Be sure you do your due diligence when selecting a broker.
#2. Technology Risk: In a trading world run almost entirely on computers, the effects of a hard drive crash, power loss or Internet connection drop out can be drastic.
At a bare minimum you should have daily backups of your computer on a separate hard drive or other backup system. And if you are a serious trader consider investing in a surge protector, power generator and backup dial-up Internet connection.
It might seem like overkill now but may just save your skin in an emergency.
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#3. Market Risk: This is the only type of foreign exchange risk management most traders think about — how daily fluctuations of currency values affect our positions.
The most sure-fire way to alleviate market risk is to trade using a proven trading system that integrates foreign exchange risk management strategies at the base level.
This includes having set entry and exit points, profit targets, and stop losses.
#4. Political Risks and Economic Risks: Major changes in political policies, large scale economical emergencies and intervention from a country’s governing authority can all effect the value of a currency.
Again, trading using a proven system with sound foreign exchange risk management strategies built-in can help defend these types of risks.
#5 Country Specific Risk: Last of all we have country specific risk — the risk of a country defaulting on it’s financial commitments.
When this happens the effects trickle down to all other financial instruments in the country and the other countries it’s doing business with.
These risks can be minimized simply by sticking to the major currencies while avoiding new, less-stable markets.
As you can see, there are many more risks involved with forex than just market risk. Broker, technology, market, economic and country risk must all be taken into account and mitigated.
Luckily, many existing trading systems have in-built foreign exchange risk management strategies to deal with, and eliminate, many of these risks.
However, even the most sound foreign currency risk management strategies are still not perfect, and there will always be some risk involved when trading. Always use your own best judgement about your risk tolerance levels and never trade above your head.
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