There are numerous forex market risks which have the tendency to affect the performance of traders and may not help them achieve their financial objectives. To discuss risks affiliated to foreign exchange market in detail, let us know about the foreign exchange market first. Foreign Exchange Market The foreign exchange market constitutes the buying and selling of currencies throughout the world. The objective pertaining to forex trading is to yield a net profit. Traders investing in the forex market have access to choose from a wide variety of currencies and for this reason, forex markets have high trade volume and are considered largest in the world in term of trade volume. However, with high volume, forex assets are highly liquid assets and hence bear the considerable amount of risk which may sometimes result in severe losses for the traders.
Image source Interest rate risks As we all know, interest rates have the capability to affect exchange rates of a country. If interest rates of a country rise, then it results in an increase in strength of the currency due to an inrush of investments in country’s assets because stronger currency leads to better and higher results. On the other hand, if the interest rates fall, then the currency is likely to get weak as investors do not tend to invest and more likely to withdraw their investments due to a weak currency. Due to this scenario, interest rates and their effect on exchange rates, forex prices can dramatically change leading to risks for the traders. Leverage Risks In forex trading, to acquire access to substantial trades in foreign currencies, leverage requires small initial investment called margin. Small price fluctuations can lead to margin calls which require investors to pay more. During volatile markets conditions, there can be losses due to excessive use of leverages.
Counterparty risks The company who provides assets to the trader or investor is known as counterparty. Hence, counterparty risk is associated with the risk of default from the broker or dealer in a financial transaction. In some trades such as spot or forward contracts, there is no guarantee made by exchange house. Therefore, during volatile market conditions, the counterparty may be unable or refuse to adhere to contracts made. Country risks
Stability of the issuing country ascertains the level of risk concerned to the forex trade. Hence, while evaluating the currencies to invest in, one must look out for the structure of the issuing country. Further, currency crisis can occur due to a balance of payment deficit that results in devaluation of the currency of that country. This situation can adversely affect the prices on forex trading. If an investor speculates that a currency will devaluate, he may start to withdraw their investments, making the currency devalue further. Also, assets of traders who continue to trade may become illiquid. Currency crisis also leads to a liquidity crisis and credit risks. With the amount of forex market risks, loses may be severe and expected returns may not be achieved. Though forex market has the highest trade volume, the risks make it harder for investors to trade. Thus, investors must consider all the risk before investing and keep ongoing research and understanding of the market to adapt to changing market conditions while trying to avoid risks.