FX 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.
Some people might laugh at going to these lengths, however anyone who has experienced a serious computer crash knows how devastating it can be, and it could be a lot worse if you were caught in a trade with no way of getting out.
#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. Economic and Political Risks: Political policy changes, major economic emergencies and governing authority intervention can all have an impact on a country’s currency value.
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.
Defaults can have serious effects on many other financial instruments throughout the country, as well as in other countries doing business with that country.
You can avoid these risk by trading only the major currencies and staying clear of emerging markets and countries with serious financial deficits.
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.
The good news is risks can be managed and mitigated, and most sophisticated trading systems already have strategies for dealing with 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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