Currency Trading is a very attractive option where a person can earn profits and at the same time there are certain risks involved which an investor should understand before trading in currency futures market.
What are the risks involved in Currency Trading?
Like any other trading instrument, there is a high level of financial risk in currency trading. Particularly increased amount of leverage offered means a trader can lose all or a large portion of the capital invested if the market moves against the trader’s position.
Exchange rate risk: The fluctuation in the supply and demand in the forex market is the main reason for exchange rate risk in currency trading on exchange rate position. As long as the position is outstanding it will be subject to all the changing prices. Thus trading should be done within a manageable limit. The two preferred limits are position limit and loss limit.
Day light allows a trader to carry maximum no of currency during the day. It should reflect the traders trading skill as well as the amount peaked.
Overnight position allows a trader to trade outstanding position kept overnight. This limit is smaller than the daylight limit.
The loss limit is enforced by authorities in the dealing centre for avoidance of major losses made by traders. The limits are selected on daily and monthly basis.
Implementing the limits with computerized system is convenient. The authorities have continuous and instant access for all positions and profit and loss.
Interest Rate Risk: The interest rate risk is related to currency swap, futures, options etc in currency trading. It is the profit and loss generated by fluctuations in the forward and forward amount mismatched and maturity differences in the transactions in the forex book. If the amount involved is small then it is not a problem. Traders will balance the overall net payments andthe receipts by means of a special type of swap which is called the next tomorrow or the rollover daily.
The limits differs from bank to bank but a common approach to separate these mismatches based on the maturity dates, up to six months and past six months. Calculating the position and profit and loss is done through computerized system. Continuous analysis of interest rate is essential to predict the changes which can affect the outstanding gaps.
Credit Risk: A possibility of non-payment of outstanding currency position due to voluntary/involuntary action by another party is called credit risk. Trading takes place on regulated exchanges without any credit concern. There are two types of credit risks, replacement risk and settlement risk.
It can be minimized through a customer’s credit worthiness. Traders and investors involved must have credit lines with each other to trade.
Country Risk: The country credit risk mainly occurs due to the government interference in the forex market. The government involvement in the forex activities is still present. Investors should be able to predict any restrictive changes relating to free flow of currencies.
Currency Trading is an attractive option to gain profits which involves certain risks also. Thus to be a successful trader you need to be aware of these risks and plan in order to minimize the risks to your investing capital involved in forex.