Forex trading is highly rewarding but potentially risky especially for naïve traders. A forex trader should know about the techniques of measuring risks, pricing it, managing and accepting it when it is ready to earn profit. Success in foreign trade is dependent on how well this assessment, management and pricing is done. Trading in forex was earlier the domain of large financial institutions and banks. They used forex trading to hedge or protect their exposures in foreign market. Since forex trade opened its gate to retail investors, earning from forex is increasingly getting popular among investors. Managing risks and controlling exposure is essential for minimizing losses in forex market.
Apparently there are several risks involved in trading of forex products in a market. For focusing on different levels of risks, it has been divided into several categories. Credit risk and market risk are two main categories of risks involved in trading of forex. There are several other risks like liquidity, legal and operational risks involved in forex trade.
Market risk in forex deals with exposure and consequences of adverse price changes. Two major components of market risks are “risks related to exchange rate” and “risks related to interest rate”. Exchange rate risk is in-built in forex trade.
Whenever a trader takes position in currency options – forward or spot, or in currency futures; the position gets exposed to exchange risks that may go against it. The position is opened to risk until it gets covered, settled or hedged adequately.
Adverse changes in rate of interest or currency rate is referred as interest rate risk of forex trade. An uncovered or open position may change value not only with changes in spot rate but also with changes in rate of interest.
Risks in forex trade may be classified as adverse changes in absolute price and adverse changes in relative price. Probability of loss from relative price risk arises from misjudging a position. In an apprehension that the Euro will appreciate, taking position in it for offsetting position in US dollar, may go wrong. A forex trader should remain well conversant of statistical co-variances and co-relations among currencies for minimizing such risks.
Tags: Credit risk, forex trading, interest rate risk of forex trade, market risk, Risks in forex trade, Trading in forex
