In previous lectures, we have examined many aspects of trading in the foreign exchange market and the most important advantages of forex trading. In this lesson, we will go over some of the risks of forex trading and some techniques for dealing with these risks.
Why are there risks in forex trading or forex trading?
Currency trading or foreign exchange trading means the trading of trade as a commodity, and this is done through brokerage and various communication tools or anything else, which facilitates the process of trading currencies all over the world.
It is known as an OTC system. As with stock trading, the primary purpose of forex trading is to make a profit by buying currencies at a low price and selling them at a higher price.
When we compare the foreign exchange market and stocks, we find that unlike trading in the stock market, which has to analyze hundreds of companies and industries and choose the best investment opportunities among them, forex traders only focus on a relatively small number of currencies.
And you have to take into consideration that every investment has its risks. Forex trading, like any other investment, involves some risks despite its various advantages, some of which can turn into risks if misused.
The foreign exchange market is a highly liquid asset, and most foreign exchange trading involves spot transactions, forward contracts, and options contracts.
The foreign exchange market is characterized by the presence of what is known as financial leverage, which can become one of the most important risks of foreign exchange trading.
Similarly, the foreign exchange market is a decentralized market unlike the stock market, and this is considered one of the most obvious advantages of forex trading because the absence of a central market makes trading easier and faster and difficult to control by a specific person.
assets, but this feature can also become a risk because any risk in the foreign exchange market can outweigh individuals, companies, or entire industries. However, if you understand the types of forex risks and trade carefully with a trading mechanism and strategy, you can trade effectively.
What are the risks of trading in forex?
1. Leverage and Margin System Risks
As mentioned, leverage is one of the advantages of the foreign exchange market. First of all, it should be clarified what leverage is. Leverage simply means allowing smaller traders to trade large amounts by trading on their relatively small accounts.
Since the foreign exchange market or foreign exchange trading was initially limited to large investors and large account holders, brokerage firms sought to provide facilities for small individual traders to enter the foreign exchange market.
Leverage allows small investors to trade forex in multiples of their capital, and broker facilities can provide leverage of more than 1000 times the original capital.
In currency trading, leverage works through a system called the margin system, whereby a small part of the capital is allocated to allow the execution of large deals and to achieve acceptable profits.
Fluctuations in the markets may force the trader to pay additional collateral. In volatile market conditions, the active use of leverage will lead to large losses that can exceed the initial investments or capital, and that is why we say that leverage is a double-edged sword because your entry into a larger-size trade increases the amount.
The increase in profit from trade also increases the number of losses, in other words, leverage is an expansion tool that magnifies the outcome of the trade regardless.
Many traders in the foreign exchange market rely on opening multiple forex trading positions at the same time with no maximum loss limit on their trades to make big profits in the end.
In this case, the risk of financial leverage is greatly reduced because, as mentioned, the loss may be greater than the size of the transaction amount, and as it worsens, it may reach more than the original capital.
Therefore, please be careful when dealing with trading and leverage during market volatility using various techniques that will be described in the following paragraphs.
2. Interest rate and currency risk
Forex trading is based on traders in the foreign exchange market changing one country's currency to buy another country's currency or selling a currency to buy another country's currency, and changes in the relative value of the currency can result in profit or loss.
When you buy and sell foreign currencies in the forex market, you are betting on the exchange rate of the two countries currencies against each other. All other factors being equal, if you buy a currency and it increases in value against the other currency, you will make a profit, but if the currency decreases in value, it will hurt you even more.
It should be noted that the exchange rate is closely related to the interest rate in each country, so higher interest rates tend to attract more investment in the country and its currency. On the contrary, lower interest rates will lead to divestment, which will weaken and devalue the country's currency.
In other words, higher interest rates provide higher returns to lenders in the economy than in other low-interest countries. The opposite happens when interest rates are lowered, i.e. lower interest rate leads to lower exchange rates.
Therefore, anyone who trades in the foreign exchange or forex market should pay attention to this relationship before initiating any trade and plan to manage the trade and exit the trade, and this certainly comes with a global following over time. An economic calendar of currencies with information about developments, learn forex trading, and important and influential data.
3. Geopolitical risks - international
If you decide to enter the foreign exchange market, you should make a general assessment of the economic and political situation of the country that owns the currency in which you intend to invest at that point. Risk components can be divided into two main categories.
The first category, straightforward and obvious, is that instability in a country can affect that country's currency. When any negative event occurs and the traders are afraid of the possibility of a bad event, the traders usually take their money away from the currency of that country, and this is considered a form of risk aversion, and thus the selling starts in the market. currency depreciating.
This appeared during the period that witnessed talks between the European Union and the United Kingdom to reach a trade agreement between 2015 and 2020 AD, after the United Kingdom’s exit from the European Union bloc.
And with the expectation that the two sides will not reach an agreement, the pressure on the pound increases and the British pound retreats for fear of realizing the scenario of a no-deal exit from the European Union, which weakens the British. the economy thus weakening the British currency, the pound sterling.
As a forex trader, you don't want to be on the wrong side of a trade when a currency drops in value. Also, political turmoil can occur in a country and this affects the market in that country, so you may find yourself stuck in the trade and incur more losses.
As mentioned earlier, learning to trade requires constant monitoring of global developments and political news, and this opportunity will be provided through continuous monitoring of foreign exchange market developments and forex news through the Arab Trader website.
The second category occurs when a country deliberately devalues its currency, and some traders in the foreign exchange market refer to this as devaluation or devaluation.
It should be noted that the purpose of the state in applying such a measure is not bad in itself, because in this country it is merely a tool of monetary policy, in which the state deliberately devalues the currency to allow it to compete more effectively about the commercial aspect.
With a cheaper currency, a country makes its exports cheaper because the goods it exports are then cheaper on the world market, and thus earns more return on its exports, which is driven by the demand of importers.
Operational or counterparty risk
In trading or any financial transaction, the counterparty is the companies or persons who provide the investor with the assets or carry out the agreement and with whom the agreements are initiated. Thus, operational risk or counterparty risk is represented if the counterparty fails or is unable to fulfill the obligation entered into in executing or settling the transaction.
To understand the matter more clearly, we say here that when trading forex, the counterparty is the brokerage house through which you execute orders in the market through you or through the trading platform that you provide, and your choice of company or broker is bad.
It may pose a direct risk to your transactions if the Company does not enforce your trades or fails to execute them at the prices you set when opening or closing those trades, and sometimes the problem is likely to take away your profits. the company, so there are important considerations when choosing a brokerage firm if the application process is to go smoothly.
How can you avoid the risks of forex trading?
There are some important aspects to consider before starting trading in the foreign exchange market, including those related to the investor himself and the psychology during trading, including those related to capital management and market risk. They should all be aware of the trading process itself and the management of the trade and make sure that the trading risks are minimized as much as possible and try to achieve success and profit from trading in the market.
1. Learn to trade
If you want to enter the foreign exchange market for the first time, you will need to know as much as possible about the topics related to the field of forex trading. No matter how experienced you are in the forex market, there are always new things and information you need to know, so keep reading and learn how to trade and everything about the forex market.
The Arab Trader website contains many tutorials and videos to teach forex and provide basic information to anyone who wants to get into forex or trade in the foreign exchange market. The site also offers lessons on topics related to technical analysis or fundamental analysis.
2. you shouldn't risk money you won't afford to lose
One of the basic rules of risk management in forex trading is not to risk more than you can afford to lose. While this rule is one of the foundations of trading in the markets in general, breaking this rule is very common and is a frequent mistake made by many, especially among beginners in forex trading, as they treat the idea of trading as a tool.
Quick gains turn speculation in the financial markets into a private gamble. Due to the difficulty of predicting market movements during market fluctuations, the trader who risks more than he can bear exposes his account and himself to great losses because of the risks he is exposed to. They are under great psychological pressure that negatively affects their decisions.
And at some point, you may suffer a big loss or lose a large part of your trading capital and as a result of psychological pressure, you will try to challenge or take revenge on the market on the same principle as the gambler after a big loss.
You are trying to make up for the loss you lost on the first trade. However, increasing the risk when your account balance is already low is one of the worst things you can do with your trades. Instead, consider cutting back on your trading volume, taking some time to study the causes of losses, or taking a break until you choose a trade with a high probability. make a profit.
3. Use stop-loss orders
Using a stop loss in trading is not optional. Stop loss is one of the main tools that allow a trader to protect his trades from unexpected market movements as a certain price is predetermined at which the deal is closed automatically.
Therefore, if the price moves in the opposite direction to your expectations and instead of continuing to bleed, continue to take losses and withdraw your capital. A stop loss puts you out of the trade relative to the amount of risk you are taking, so you have enough capital to help you recoup your losses. Remember that a new deal is a new risk and needs balance to re-enter.
It is important to note at this point that the stop loss is not a complete guarantee of protection against losses because there are situations in which the market moves suddenly causing gaps and the prices move volatilely, in this case, the stop loss will not be executed at a predetermined time the level will be executed, but it relatively close. In this case - which happens infrequently - the stop loss is a guarantee or partial protection against losses that do not happen often but must be noted.
4. Use Take Profit
The Take Profit order is similar to the Stop Loss order, but it seems to have the opposite name. As mentioned above, the Stop Loss order is designed to automatically close trades to prevent further losses, while the Take Profit order is designed to automatically close trades after they reach a certain level of profit.
Many trades can initially work in line with your expectations, and by setting a clear forecast for each trade, you can set your expected initial profit target for that trade, and thus set your take profit level, whatever the winds.
You do not want to charge and the trade will bounce back due to market volatility or news and you will lose what you made and you may also lose some of your capital after making a profit.
5. Wise use of leverage
In the previous paragraphs, we have covered several risks that a trader faces in the foreign exchange market, including the use of financial leverage. We repeat that leverage is a double-edged sword, or overuse in the sense of making more deals, or exploiting the idea that it allows you to open relatively large deals on your account size in the hope of making more profits.
In the event of a loss greater than you can handle, determine your acceptable risk size before you start trading, and do not open more trades or volumes than you can afford to lose.
As a general rule, your exposure to foreign exchange market risk is higher with higher leverage. If you are a beginner in forex trading, the best approach in terms of risk management in forex trading and the foreign exchange market is to limit the risk of loss by not using high leverage.
6. Develop a solid forex trading plan
One of the most common mistakes is starting trading and executing trades without having an effective trading plan. Creating a trading plan is one of the most important steps to take before starting the trading process.
We can also say that making the right plan is the first step to success in any business you want to do.
In the trading plan, you must first include your goals in the trading process, the size of the risk, the extent of your acceptance, and the amount of money you are willing to lose, which must be realistic, and then choose the brokerage firm.
If you intend to deal or trade, then develop a trading strategy or trading system that includes the analysis mechanism, sources of news tracking, economic data or analysis, and finally the analysis method, entry place, and reason. Agreement, place, and reason.
Once you have a forex trading plan, stick to it anyway because a trading plan will help you to focus and think rationally away from whims and emotions while trading.
With a trading plan, your entry and exit strategies are clearly defined and you will know when to take your profits or cut your losses without fear or greed.
By following the experts and learning more about the foreign exchange market, you can develop a strict trading plan by constantly monitoring the plan and evaluating the performance of your trades from time to time by testing and changing the plans. You can constantly improve your performance and keep your profit curve rising according to results and numbers.
7. Always prepare for the worst
No one can predict the movements of the foreign exchange market with certainty, but there is a lot of evidence from the past about how the markets functioned in certain situations and events.
That's why it's important to look at the historical movements of the currency pair you're considering trading, think about that pair's movements and the worst swings that affect it, and consider those swings and worst-case scenarios as you develop your risk. A trading plan is to calculate the maximum risk to your account should it occur so that you can handle it when it does.
8. Control your emotions
As mentioned in the previous paragraphs, forex trading is highly dependent on the psychology of the trader and a trader who relies on feelings and whims will not succeed. The trader must be able to control his emotions.
When you have access to the ability to focus and let go of emotions, and you have more confidence in data with a degree of organization, commitment, and self-control, you will be able to profit.
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Forex trading