Any investment that offers potential returns also carries some risk factors. You may lose more than the value of your transaction when trading at a margin. Forex trading includes trading of currency pairs. It also has some risk factors described below:
Exchange rate risk
A change in currency value causes the exchange rate risk. It is the possibility that the price of investment changes when the currency is exchanged. This happens when there is a movement in the exchange rate between the placement of the order and the transaction’s completion. The risk of the exchange rate is related to all foreign investment.
Interest rate risk
Interest rate risk refers to the profit and loss caused by the variations in forwarding spreads and forward gaps and maturity gaps between transactions in the foreign exchange book. This risk is related to currency exchange, future, forward outright, and options. To minimize the interest risk rate, one can set a limit on the total size of the gaps.
Errors in management, communication, and verifying a trader’s order (sometimes also known as “out-trade”) can cause unexpected losses. Transaction risk refers to the negative impact that fluctuation in the foreign exchange rate can have an entire transaction before it is settled. This transaction’s risk increases when there is a long delay between entering into an agreement and concluding it. The transaction risk can be reduced by using options and forwards agreements to prevent negative exchange rates.
Foreign exchange usually requires low-margin reserves or trading collateral (such as regulated commodity futures). These margin policies allow for higher leverage. For this reason, a relatively small price in contact can amount to a far more significant and immediate loss than the amount invested.
Some traders may agree to pledge up to 100% of their account assets for collateral or margin for Foreign Exchange trading. Traders should know that during periods of unfavorable performance, aggressive use of leverage will increase losses.