FX Risk Management Ideas

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: A broker is a business like any other, and as such they can face the same problems any regular business can, including bankruptcy.

Experienced traders might remember the 2005 Refco fiasco where one of the largest and most respected brokerage firms in the forex markets went bankrupt. The effects of this are still being felt today.

Always spend some time thoroughly investigating potential brokers before you get seriously involved with them.

#2 Tech Risks: There’s no doubt that computer, power or Internet issues could seriously dampen your results in the markets. With trades sometimes needing to be made at precise times, and Murphy’s law in full effect, you should always prepare for the worst when it comes to technology.

I strongly suggest you backup your computer on a daily basis, preferably to an off-site location you can backup from in case of fire or theft. Traders with serious commitment to the markets, or sizable portfolios, should invest in fail-safe backup systems including generators and surge protectors.

It might seem like overkill now but may just save your skin in an emergency.

#3 Market Risk: How market changes affect your positions. The most common type of risk people associate with forex.

You can largely eliminate large losses that arise from market conditions by using stop losses and following trading systems with in-built entry points, exit points, and profit targets.

#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.

You can avoid these type of risks by using a trading plan that integrates solid foreign exchange risk management methods and identifies issues before they impact your positions.

#5. Country Risk: Finally, there is the risk that a country won’t have the money to meets it’s financial commitments, and will default.

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.

I hope it is now clear that the risks involved in trading forex are deeper than the surface market risk most people are familiar with.

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.