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Forex Risk - How to Manage it and Become a Successful Trader

Forex risk is the probability of loss occurring from an adverse movement in foreign exchange rates whilst holding a long or short position.

Managing Forex Risk

One of the advantages that attracts investors to forex trading is the higher leverage available as compared to the other financial markets. One of the greatest mistakes a newbie forex trader can make isn't knowing the effect leverage has on their bottom line. You have to pick the best forex system for risk management.

What is leverage?

In the forex markets, leverage is where a forex trader controls an amount of money with a bit of his own money (margin) and borrowing the remainder from his fx broker.

Example

A trader with an $1,000 margin, can control $100,000 of foreign currency. The leverage, expressed in a ratio is 100:1. Now if we invest this $100,000 in a foreign currency, which in turn subsquently rises to a value of $100,500, that is an increase of $500.

What is the return on the investment?

If we had invested at a leverage of 1:1, which would mean we invested $100,000 to control $100,000 worth of foreign currency, so the return could be $500, or a miserly 0.5%. But now when we invested with in the same trade with 100:1 leverage, which would mean that for an margin of $1000 we'd control $100,000 of foreign currency. The return in this trade would be $500 on an intial investment of $1000, or a massive 50% return.

Leverage - the double edged sword

That is all well and good but if the investment / trade went the other way and the investment lost value and returned only $99,500. Well if we were forex trading at a leverage of 1:1, we'd lose $500 or 0.5%. That's no serious problem when you start with $100,000. It's a different story if you were trading at 100:1 leverage. A $500 loss on an investment of $1000 is minus 50% return on your money and that is a big problem when you started with $1000.

How to use leverage to minimize your forex risk

With the above examples, it is not difficult to see that one of the most important aspects of managing foreign exchange risk is making sure you apply suitable leverage to your forex account. The greater the leverage the bigger the profits but the downside is the highly leverage accounts likewise have potiential to rack up massive losses. By choosing the correct leverage for your account, this can enable you to place your stop loss orders with enough room to cover any spikes in the forex market. Every fx trader will at some time or other have a series of trades go against them. This is the nature of forex trading. But having a run of losing forex trades and too much leverage can result in your account being emptied in a flash. The majority of the foreign exchange brokers will have a variety of different leverage options. So make sure that you select the correct leverage for the size of your trading account. To be a successful fx trader it is esstential to have a good foreign exchange risk and money management strategy.

Now, if you would like to invest in foreign exchange accounts, make sure you invest only to whom you can trust. Reliable system, good history and reputation.
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