Foreign Exchange Risk Management Methods
Thursday, February 11, 2010 at 10:52AM By Grant Grady
Veteran and amateur traders alike must understand foreign exchange risk management methods if they hope to have any chance of financial success in the long run.
Unfortunately, many traders do not think about foreign exchange risk management at all. Or if they do, they only think about market risk. Serious traders understand there are at least 5 types of risk associated with trading forex, and market risk is only one small one.
In this article we'll explore the 5 different types of risk you're exposed to when trading the forex markets, and ways you can lessen, or even eliminate, your exposure.
Please do not take this as an exhaustive list, nor as a deterrent to trading, it is only meant to help expand your awareness of foreign exchange risk management and prepare you for a long term, profitable run as a forex trader.
The 5 Major Risks in Forex and How To Manage Them
#1. Broker Risk: There is always a small chance that your broker will go bankrupt or otherwise meet their demise.
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.
Be sure you do your due diligence when selecting a broker.
#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: This is the only type of foreign exchange risk management most traders think about -- how daily fluctuations of currency values affect our positions.
The most sure-fire way to alleviate market risk is to trade using a proven trading system that integrates foreign exchange risk management strategies at the base level.
This includes having set entry and exit points, profit targets, and stop losses.
#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 Specific Risk: Last of all we have country specific risk -- the risk of a country defaulting on it's financial commitments.
When this happens the effects trickle down to all other financial instruments in the country and the other countries it's doing business with.
You can avoid these risk by trading only the major currencies and staying clear of emerging markets and countries with serious financial deficits.
As you can see, there are many more risks involved with forex than just market risk. Broker, technology, market, economic and country risk must all be taken into account and mitigated.
Luckily, many existing trading systems have in-built foreign exchange risk management strategies to deal with, and eliminate, many of 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 judgment about your risk tolerance levels and never trade above your head.
Did you enjoy this article? Get more in-depth articles, reports and a free newsletter from Grant at Easy Forex Trading Strategies.
And if you're new to forex, or just looking for a proven system to follow, then you'll want to join hundreds of other traders who have invested in Grant's recommended Forex Currency Trading System.
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