Managing Foreign Exchange Risk
Managing foreign exchange risk might seem like a tall order in today's topsy-turvy forex market. The risk presents itself regardless of whether you are a Forex trader or if you simply buy materials from another country. With the fluctuations in the exchange rate on a minute to minute basis, you never know what you're going to get out of an exchange. Find out how to limit your exposure as much as possible
When I talk about risk, I'm not talking about the classic board game (although that would be awesome). Although it may be nice to roll the dice and advance your armies on countries at your command, the FOrex market works a little differently. The primary difference is, no one uses dice to control the market, they simply use trillions of dollars. Not really...no one single entity can control the market. But since you never really know what the market is going to do, you need to do as much is possible to reduce your personal risk. Here are a few strategies you can use to limit risk.
On the most basic ways that businesses limit their foreign exchange rate risk is through a forward contract. With a forward contract you agree to buy a certain amount of a foreign currency at a specific price at a point in the future. If you plan on buying a certain amount of goods from another country on a specific date, this can be a welcome maneuver. You really don't know what the market will do between now and then, so this can sometimes be an effective way to get the currency for cheaper.
Another simple way to tackle managing foreign exchange risk is to place a stop loss order. Stop loss orders are available at most Forex brokers. With a stop loss order, the broker will close out your position if the market moves in the opposite direction of your trade past a certain point.
For example, you could open a trade with a 50 pip stop loss. Then if the market moves in the opposite direction of your trade by 50 pips, your order will automatically be closed out. This can be an effective way to limit the amount of money that you lose on a trade.
The only problem with this type of trade is that sometimes brokers will not honor them in times of high volatility. When working with a broker, it is important to find out if the stop losses are guaranteed or if they can be ignored.
By using money management principles on every trade, you can also reduce the amount of money that you lose in the market goes against you. Choose your lot sizes based on the amount of money that you want to risk on each trade. Risk a maximum of 1 to 3 percent of your account balance on each trade. This way, you can always live to play another day.
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