5 Risks The Novice Forex Trader Should Be Aware Of

Foreign currency trading, just like many other types of trading, carries risks and the novice Forex trader needs to know these before starting to trade. Here we will consider the five most commonly encountered risks of foreign currency trading.

1. Forex scams. Recently the industry has done a great deal to put its house in order and nowadays Forex scams are unquestionably a lot less common than they once were. They do however still happen.

It is reasonably simple to open a Forex trading account, particularly using the Internet, and a Forex scam in its simplest form is a case of a crook operating a website posing as a broker, inviting you to establish an account and fund it and then disappearing without a trace.

To ensure that you do not get caught out you need to check out any broker carefully prior to opening an account. Choose a broker who is associated with a major financial institution (for example, a bank or insurance company) and who is also registered as a broker. In the US brokers are registered with the Commodities Futures Trading Commission (CFTC) or will be a member of the National Futures Association (NFA).

2. Exchange Rates. One of the pulls of the Forex market is that it can be very volatile with currencies moving a lot against one another in very short time periods resulting in fast and significant gains. The other side of this coin however is that the volatility in the market also produces large and rapid losses.

Fortunately there are tools available to the trader to limit this risk and novice traders need to learn how to use these tools and ensure that they make full use of them whenever they enter a trade.

3. Credit Risk. Because there are always two parties (a seller and a buyer) taking part in every trade there is always a possibility that one party will not honor his or her commitment once a deal is completed. This generally happens when a bank or financial institution declares insolvency.

You can lessen any credit risk substantially by trading only on regulated exchanges which require members to be monitored to ensure that they are credit worthy.

4. Interest Rate Risk. When you are trading a pair of currencies you have to look for discrepancies between the underlying interest rates in the two countries in question because a discrepancy can lead to a difference between the predicted profit and that which you actually receive.

5. Country Risk. From time to time a government will intervene in the foreign currency exchange markets in order to limit the flow of its country’s currency. It is unlikely that this will take place in the case of a major world currency but could occur for minor and less frequently traded currencies.

These of course are merely a few of the risks of foreign exchange trading and new traders will have to acquaint themselves with the other risks as they go. Nonetheless, a sound knowledge of the risks given here is essential before you start to trade.