Whenever you see an advert for financial products such as savings and investments, you will see with it a legally obliged statement informing you that trading and investments based on the stick and money markets are never without risk, and that the value of shares and other commodities can go down as well as up.
This should act as a universal warning across the board, when dealing with dynamic markets that can be impacted by a myriad of changing circumstances, including both sudden events and gradual trends. These can sometimes provide great opportunities for an upturn in your fortunes, but may also pose downside risks of you being caught out.
Starting with the basic premise that you do face risks is the first thing that should inform your Forex trader decision-making. It means you should guard against complacency, remain vigilant and work with partners who can help you make the right choices, often at short notice when circumstances change.
Of course, you can give yourself the best possible chance of success by partnering with a strong prop firm with an eye for good opportunities but also a nose to sniff out emerging risks.
By reading reviews on prop firms you can make it easier for yourself to identify a prop firm that you can work with in confidence, knowing these are smart operators who do not take undue risks with capital but are very aware that no investment strategy is immune to the slings and arrows of fortune.
Alongside that, it is also important that you educate yourself about the nature of risks in Forex trading.
For instance, if you have a short-term strategy, based on trading currencies at what appears a specifically favourable window of opportunity, be aware that sudden, short-term changes could provide a negative impact. If a market is volatile, that can raise the risk levels.
Brexit: A Prime Example Of Market Volatility
To give an example, consider Forex traders involved in trades involving Sterling in the wake of the 2016 referendum on British membership of the European Union.
Anyone making trades based on the assumption that Remain would win and the pound gain a boost in value once the uncertainty was removed will have got their fingers badly burned by the shock victory for Leave.
Thereafter, Forex traders making transactions involving either buying or selling Sterling were left with a highly volatile market. At first, the pound plunged in value against the Euro and Dollar. Then it recovered as Theresa May replaced the resigning David Cameron as prime minister and confidence grew that a solid leave deal could be secured.
However, Sterling then dropped again once Article 50 was invoked, while it bobbed like a cork on choppy waters as sentiment about a possible deal fluctuated between optimism and pessimism. The calling of the 2017 general election boosted Sterling as Mrs May expected a greatly increased majority. What transpired was a hung parliament and more uncertainty.
After this, an extension to the timetable and an unwillingness to countenance a ‘no deal’ Brexit raised Sterling, but Mrs May’s failure to get a deal through parliament and her subsequent resignation and replacement by Boris Johnson, who was prepared for a ‘no deal’ if necessary, sent the pound plunging again.
Finally, the currency was up again when the 2019 general election brought certainty, but down when a post-Brexit trade deal looked unlikely until finally agreed upon just before Christmas 2020.
This series of fluctuations amid such economic and political uncertainty shows just how much risk there was for anyone taking a chance on the course of Brexit working out as they had anticipated.
The Danger Of Sudden Shocks
Another example might be the impact of sudden economic and geopolitical shocks. There have been plenty of these in the 21st century; the 9/11 attacks that sent stock markets plummeting, the 2007 credit crunch and subsequent 2008 economic crisis, the Covid-19 pandemic, and Russia’s invasion of Ukraine.
Nor is it just human action or error (including in failing to contain Covid) that can impact Forex markets; so too can sudden natural disasters like earthquakes, floods and fires, as these cause economic damage both through immediate disruption and the longer-term impact of damaged infrastructure and lost lives.
Some of these events can be predicted up to a point. For instance, American intelligence services had been warning that Russia planned to invade Ukraine for months before it happened, although many did not believe it would happen. Some natural disasters, like Hurricane season in the US or Australian summer bushfires, are seasonal.
However, many events come out of the blue and whether a disaster, act of terror or sudden economic event like a stock market crash, such events can catch Forex traders on the hop and defenestrate the most carefully laid of plans.
Not All Shocks Are Sudden
Furthermore, it is important to remember that risk is not just about sudden events, just as your trading strategy may have a more long-term basis, such as an investment based on the assumption that while a currency may fluctuate in value in the near term, its overall trend will be upward.
In this instance, the risk lies in any gradually emerging issues that might negatively impact on the economy and currency concerned.
A good example right now would involve carry trades involving two currencies with divergent interest rates, where you buy the currency with the higher rate while shorting the one with the lower rate.
Such trades would commonly use the Japanese Yen with its minimal interest rate and Western currencies with much higher rates, although this differential all but vanished after the 2008-09 financial crisis when base rates plunged to less than one per cent everywhere.
That development would have wrecked his strategy, although traders will have had some chance to see it coming: the Bank of England for example, did not cut the base rate from five per cent to 0.5 per cent overnight, but from five per cent as late as October 2008 to half a per cent in March 2009, with six reductions. This offered time to adjust strategies.
Planning For Risk
While there are both short and long-term risks for traders, it is important to plan for these.
An understandable but not particularly wise response would be to shrug your shoulders and accept that, now and again, you will be stung by unexpected developments that cause you to make a sudden loss. While such philosophical stoicism may seem realistic, it is also unnecessarily fatalistic.
The reason for this is that while you may not know just which risks may turn out to be the ones that actually strike, you can devise a trading strategy that does not put all your eggs in one basket. For example, by trading in more currencies you spread the risk, as a development that this one country and its currency may not impact at all on another.
You also need to be aware of the basic principles of risk and reward. If, for example, you are taking a risk by expecting a geopolitical situation to develop in one particular way, you may find you make a high yield in getting it right. But equally, should you get it wrong you have to accept a serious loss.
For this reason, you need to consider just how much capital you are prepared to use in such a way. You have to consider how much loss you can tolerate if things go wrong and act accordingly. A good way of doing this could be to dedicate the bulk of capital towards lower-risk trades, making it likely you will have good returns to help you afford a few riskier moves.
This concept of spreading risk means that you may be carrying out some different trades on any given day, although this should not be too many. After all, if you are involved in a lot of different activities that can each be impacted by changes in circumstances, it can be harder to keep your eye on all of them.
The Lowest Risk Options
Another way to respond to the reality of risk is to almost eliminate it. This can be done through either a forward contract or a futures contract, both of which involve a prior agreement between two parties to buy or take delivery of currencies at a pre-agreed price.
These remove risk because you can be sure you won’t have to pay more than you expected if buying or earn less than anticipated if you are selling. Because of the agreement, any events that shift the open market won’t change the transaction cost.
Of course, this cuts both ways; you might end up agreeing on a price you are happier with, but which turns out to be less favourable to you than had you not done so, due to developments impacting the market between the making of the agreement and the transaction taking place.
However, because you will have agreed to a figure you are comfortable with, this will not amount to a loss for you, just not as big a gain as might have been the case.
Almost nothing in life is risk-free, so it is no surprise that this applies to Forex trading as well. What matters is that you are aware of this, ready to respond when circumstances change, and have a sound strategy that manages and limits your exposure to bigger risks.
