The Forex market is the largest financial trading market in the world in terms of volume. It is precisely because of the large trading volume that foreign exchange assets are listed as highly liquid assets. The types of foreign exchange trading include spot trading, forward trading, foreign exchange swaps, currency swaps and options, but as a leveraged product, foreign exchange trading risks will be amplified, which may lead to unexpected losses.

What you need to know is that the risks of trading forex far exceed those of trading stocks. However, if you understand the risk or know how to avoid it in most cases, and trade conservatively, you can effectively protect your principal and have a good chance of making a profit.

Risk in foreign exchange

1. Transaction risk

Forex trading takes place 24 hours a day, which can result in significant changes in the exchange rate at the time the trade takes place and is settled.

Transaction risk in international trade: The relative value of two currencies may change between the time a transaction is made and the time payment is received. If you are not properly protected (hedged), an appreciation or depreciation of a foreign currency can cause you to lose money.

For example, if the buyer agreed to pay $500,000 for a shipment, at a time when $1 could be exchanged for 0.85 euros, you would expect to receive €425,000. But then the dollar depreciated to 0.84 euros and you would only receive 420,000 euros for the payment made at the new exchange rate, which means you would lose 5,000 euros. However, if the dollar appreciates, you will reap a windfall profit.

Trading risk in capital markets: When you trade forex, you are predicting the value of different countries' currencies against each other. Unlike stock trading, which is only related to an enterprise or an industry, there are many factors affecting the value between two currencies in foreign exchange trading, such as the economic policies of different countries, the release of various economic data, and the speech of a well-known person will affect the change of exchange rate.

In addition, the forex market runs 24 hours a day, but people need to rest, so it is very likely that after you fall asleep, a sudden news can wipe out all your profits.

2. Interest rate risk

If a country's interest rates rise, its currency will appreciate due to an influx of investment in the country's assets. Conversely, if interest rates fall, its currency will depreciate as investors start pulling out of their investments.

Due to the nature of interest rates and their direct impact on exchange rates, forex traders must be aware of this relationship before making a trade. Some of the most influential central banks in the world, including: the Federal Reserve, the Bank of England, the European Central Bank, the Bank of Japan, the Reserve Bank of Australia, the Reserve Bank of New Zealand, the Central Bank of Canada. (Interest rate data from China's central bank have also gained influence in recent years, a testament to the yuan's growing role in global financial markets.)

They release the latest interest rate data every month, which has a huge impact on the value of the local currency (it is normal for the currency to move 30-50 points in the minutes before and after the data is released), and this is the economic data that forex traders focus on every month.

3. Country risk

We can divide country risks into two broad categories: the first is immediate, where instability in a country affects its currency. When an adverse event occurs, or traders fear that an adverse event may occur, investors often move their funds out of a country's currency, which has the effect of devaluing the currency. It can happen quickly (i.e. in the midst of political turmoil) and lead to illiquidity in the market.

The second category is when a country deliberately devalues its currency. This is another type of country risk, which some traders call centrally regulated risk. This in itself is not a bad thing, it is just a form of monetary policy. But under this policy, a country purposefully lowers the value of its currency in order to compete more effectively from a trade perspective. A cheaper currency makes a country's exports less expensive in export markets.

4. Margin (leverage) risk

Using leverage in forex trading is no different from using leverage in stocks and options. When you trade on margin, it's like you're borrowing money from your dealer, allowing you to control a larger trade size than your principal.

While leverage can multiply profits, it can also cause losses. Even small price movements can trigger margin calls. If you are a novice, consider the main risks of margin trading before using extremely high leverage (e.g., thousands of times).

Tips to reduce risk in Forex trading

1. Start small. Start trading Forex with a small amount of money you can afford, and practice your trading skills by using a demo account before investing real money.

2. Take common-sense precautions. When you start trading for real, make sure you use stop loss protection properly and spread your available funds over several trades rather than putting all your eggs in one basket.

3. Implement feasible trading plan. Before getting involved in forex trading, make sure you have thought it through. Don't let one wrong move in Forex trading harm your near - and long-term financial health, so having a trading plan and strategy is crucial.

4. Choose a reliable Forex broker.

Sum up

In short, risk and return are proportional, which is common sense. But many people expose themselves to unnecessary risk in the belief that they can earn higher returns. As with any trading and investing activity, it is best to invest with no debt, an emergency fund and a long-term investment plan in place.