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FOREX: There Is No Free Lunch. Know The Risks

Aug 17, 2007
Though many people will try to convince you otherwise FOREX is not risk free. The majority of the people trying to convince you that it is risk free have some FOREX product that they want you to buy. When you trade you are dealing with substantial amounts of money and there is always the possibility that a trade will go against you. You can minimize your risk, there are many trading tools available that will help you trade successfully and profitably while minimizing your losses.

A few years ago the FOREX market abounded with scams, currently the industry has cleaned up significantly but there is still a risk of being scammed. You will need to use some common sense and exercise some caution when you sign up with a broker. Take your time and be sure to investigate a broker before you sign up with them. A reputable broker will be associated with some sort of large financial institution such as an insurance company or a bank. They will also be registered with the proper government agencies. Here in the US they will be with the Commodities Futures Trading Commission or they may be a member of the National Futures Association.

Even once you find a reputable dealer to work with there are still some risks involved in the FOREX exchange. All trades are susceptible to sudden rate changes, radical political events and market changes.

Exchange Rate Risks: This is the fluctuation of currency prices during the time of the trade. Prices can fall suddenly which can lead to unexpected losses, stop loss orders can be used to help mitigate this risk. Stop loss orders are used to close a trade if the currency passes below a set price level. By using stop loss orders in conjunction with limit orders you can greatly automate the process of FOREX trading. Limit orders are used to open a trade when it falls to a certain price or close it when it rises to a specified price or profit level.

Interest Rate Risk: This can result from differences in the interest rates in the two countries involved in the currency trade. This can cause differences in the expected profit or loss level of a trade.

Credit Risk: This is possibility that one of the parties will not honor their debt when the trade is closed. This is usually only an issue when a financial institution declares bankruptcy. You can greatly reduce this risk by only dealing with regulated exchanges that monitor the credit worthiness of the members.

Country Risk: This refers to when the government in a country becomes involved in the currency exchange by limiting the availability of the currency in the market. This is a greater risk when involved with the more exotic currency than if you stick to the major currencies that allow their currency to be freely traded.

This outlines some of the most common risks in currency trading. All of these risks can be reduced to manageable levels even though they cannot be completely eliminated.
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