Risks in Foreign Exchange Trading

Forex Currency trading is quite a lucrative option to gain huge profits but there are risks involved too, which a trader needs to understand well before jumping into forex trading. While trading in forex, investors come across various types of risks in foreign exchange trading. The four main types of risks involved in foreign exchange trading are defined below.

Exchange Rate Risk
Interest Rate Risk
Credit Risk
Country Risk

Exchange Rate Risk : The exchange rate risks in forex trading arise due to the continuous ongoing supply and demand balance shift in the worldwide forex market. A position is a subject of all the price changes as long as it is outstanding. In order to cut short these exchange rate risks and to have profitable positions, the trading should be done within manageable limits. The common steps are the position limit and the loss limit. The limits are a function of the policy of the banks along with the skills of the traders and their specific areas of expertise. There are two types of position limits daylight and overnight. The daylight position limit establishes the maximum amount of a certain currency which a trader is allowed to carry at any single time during. The limit should reflect both the trader's level of trading skills and the amount at which a trader peaks. Whereas, the overnight position limit which should be smaller than daylight limits refers to any outstanding position kept overnight by traders. te position and loss limits can now be implemented more conveniently with the help of computerized systems which enable the treasurer and the chief trader to have continuous, instantaneous, and comprehensive access to accurate figures for all the positions and the profit and loss.

Interest Rate Risk: The interest rate risks in foreign exchange trading are related to the currency swaps, futures, forward out rights and options in foreign currency exchange trading. The interest rate risks are those foreign exchange trading risks which refer to the profit and loss generated by both the fluctuations occurred in the forward spreads and by forward amount mismatches and maturity gaps among various transactions in the forex book. The mismatch amount is the difference between the spot and the forward amounts. On a daily basis, traders balance the net payments and receipts for each currency through a special type of swap, called tomorrow or rollover. Limits of the total size of mismatches are set up by the management to minimize interest rate risks in forex trading. However, different banks have different policies to cut back the losses. However, the most common approach is to separate the mismatches, based on their maturity dates, into up to six months and past six months. Then all the transactions are put into computerized systems to calculate the positions for all the delivery dates and the profit and loss. There is a continuous analysis of the interest rate environment necessary to forecast any changes that may affect the outstanding gaps.

Credit Risk: Other kinds of risks involved in foreign exchange trading are credit risks. These are associated with the probability that an outstanding currency position might not be repaid as agreed upon because of a voluntary or involuntary action by the other party. In such a case, the forex trading occurs on regulated exchanges, where all trades are settled by the learning house. In these types of forex exchanges, the investors of all sizes can deal without any credit concern. The following forms of credit risk are known. There are two types of credit risks in foreign exchange trading, the Replacement risk and the settlement risk.

Country Risk: The country risks in forex trading are arise in case of there are a party is unable to receive an expected amount of payment because of the government interference in the matters of insolvency of an individual bank or institution. The country foreign exchange trading risks are linked to the interference of government in forex markets. It falls under the joint responsibility of the treasurer and the credit department. The government control on foreign exchange activities is still present and implemented actively. For the investors, it is important to know or how to be able to anticipate any restrictive changes concerning the free flow of currencies.