Forex is the world’s largest financial market as traders exchange currency pairs in great volumes daily.
However, there are still risk factors involved that you need to pay attention to. You must account for leverage, liquidity, and international news that could impact any of your positions before trading.
Using Leverage is Risky
Trading on margin is very common in the currency market, as many brokers allow you to use a lot of leverage on your exchanges.
In Forex, most take on leverage by trading with their broker’s cash. They allow their clients to borrow between 10 to 100 times the amount of capital they put up front on a position.
If you are confident in your abilities and it abides by your risk management policy, levering up can be worth it as it magnifies gains. However, it also makes losses more severe as you may accrue great losses and debt.
Using leverage is especially risky if the volatility is high in a currency pair. Make sure you research, test, and follow your risk management policy before deciding how much leverage to use on an exchange.
Trading a Pair With Little Liquidity Can Be Dangerous
Currency pairs with the highest liquidity are the safest to trade. The most commonly traded pairs, such as EUR/USD, have the highest execution rate in the Foreign Exchange market.
Meanwhile, trading rarer currency pairs with low liquidity levels can be very risky. If there is not a high trading volume, then you may not be able to enter at your desired price. Also, your order to sell can potentially fail, especially if the exchange rate is volatile. When this occurs, you can be blindsided and take on much greater losses than expected.
You can typically gauge liquidity by looking at the spread – the difference between the bid and ask prices. A tight spread on a pair typically indicates that it has a high trading volume, while a wide spread suggests the opposite.
Current Events May Cause Market Volatility
Trading Forex is especially risky on days when there is a major announcement that could affect a currency pair. This is common on election days or when economic plans and information is revealed.
The suspense leading up to and immediately following these announcements make the market much more volatile than normal.
If you are unaware of these events while trading, you may be hit with major losses that could have been avoided or limited otherwise.
Utilize an economic calendar to keep track of important dates and avoid possible surprises. You may want to consider stepping back from the currency market altogether on these days if you are a beginner or risk-averse.
It is critical to acknowledge these risk factors before trading within the foreign exchange market. Ensure you monitor any relevant current events, and measure the liquidity and leverage of your positions before exchanging currencies.