As with any form of trading and investing, forex carries with it a modicum of risk. Some of the most lucrative pairs on the market are often some of the most volatile – which means that while the peaks may be high, the dips are also likely to come around thick and fast. For the average trader, this means holding your nerve and keeping a close eye on all of the statistics peeling forward.
But what is currency risk? ForexTraders has a fantastic in-depth library of advice for you to pore through in terms of wider reading. However, in the here and now, we are going to consider this particular type of risk on forex, why it is unique in how it affects FX trading, and what other risks you need to be aware of. Forex can be lucrative – and yes, it is entirely possible to make a passive income – however, heading into the market without an awareness of risk is simply not viable.
Currency risk in brief
Currency risk ultimately concerns the waves in strength and weakness that all currencies experience. For example, if GBP dips in value against USD, it immediately becomes more expensive for a British investor to purchase US goods. However, this is looking at things purely from the angle of goods transfer and trading.
Forex is interesting in this regard as, of course, you are purely investing based on the strength of money. Many people, for example, choose USD/EUR as a pair simply because it swallows up the most volume. The GDP strength and relative value of both currencies have proven to be steadfast during some of the biggest financial, social and health crises of the modern age. Therefore, playing it safe via strong pairings (normally with USD attached) is considered a wise manoeuvre to beat back currency risk.
Currency risk can plague forex investors if their asset appreciation depends on the value of the pairs they have in play. If GBP was to fall suddenly overnight, for example, and a forex investor has a GBP/EUR pair at the heart of their portfolio, they are likely to suffer some bite back from currency risk.
A simple way to avoid this, of course, is to diversify. It is not a wise move to consider placing all your forex investments in one particular pair, especially if it does not have a strong anchor backing things up. However, there are other risks you need to be aware of while trading.
Other risks to consider in forex trading
Just as there are pros and cons to investing in certain businesses, there are also strong for and against arguments when it comes to diving into forex. That said, provided that you manage a forex portfolio well, there is nothing to say that you cannot make strong passive income on the side.
One of the bigger risks to consider is time difference. Markets will open and close at different times of the day – for example, if you are trading in JPY and EUR, the market openings will likely overlap or even miss each other. Even if you time things perfectly, you need to remember that forex is open for trading 24 hours a day.
This means that there is, unfortunately, a risk of you making a trade at a specific value, and that value changing dramatically when markets open back up again the next day. Timing is essential if you want to avoid big losses.
You also need to consider how interest rates can impact the relative strength of a given currency at any moment in time. A country with a rising interest rate is likely to have a stronger currency on forex – the opposite is true if that interest rate drops. This falls in line with general currency risk, as well as socioeconomic matters that can destabilize weaker currencies.
What’s more, there is also the risk of your broker, or counterparty, dropping out of a contract or defaulting. While the best brokers will give you their word, if social or economic matters change too wildly for your seller to stick to an agreement, their dropout may risk your assets.
There is always a risk
Heading into forex without any kind of plan for risk mitigation is simply not viable. These markets are volatile simply because everyday life and political events can always set things rolling in extreme directions. Always plan ahead, and find a broker that can help you weather the potential storms to come.