Foreign Exchange Risk Management



The key to foreign exchange risk management. At all times follow the basic rule: Do not place money in the forex markets that you cannot afford to lose.

Forex trading is very profitable and also can be very risky,but there are various foreign exchange risk management strategies, that can be used to limit risk and financial exposure. Every forex trader should have a forex trading strategy; like having a plan and a timetable on when to enter and exit the market and what kind of movements to expect.

Developing strategies requires education. Every forex trader should learn atleast the basics of forex trading, understand chart movements and indicators and how charts are interpreted. There are lots of information on forex trading available both on the Internet and in print.

If you want to be successful at forex, you have to learn and make use of a foreign exchange risk management tool when trading.Even the most knowledgeable traders, however, can't predict with absolute certainty how the forex market will behave. For this reason, every forex trader is advised to take advantage of the available foreign exchange risk management tools designed to minimize loss.

Stop-loss orders: This is minimizing risk when placing an entry order. A stop-loss order gives instructions to exit your position if the currency price reaches a certain point. If you take a short position (expecting the price to fall) you would place a stop loss order above current market price. If you take a long position (expecting the price to rise) you would place a stop loss order below current market price.

Let's take for an example, you take a short position on USD/CDN, this means that you expect the US dollar to fall against the Canadian dollar. Let's take for an example also that the quote is USD/CDN 1.2138/43 - you can sell US$1 for 1.2138 CDN dollars or sell 1.2143 CDN dollars for US$1. You can then place an order like this: Sell USD: 1 standard lot USD/CDN @ 1.2138 = $121,380 CDN Pip Value: 1 pip = $10 Stop-Loss: 1.2148 Margin: $1,000 (1%)

You are selling US$100,000 and buying CDN$121,380. Your stop loss order will be executed if the dollar goes above 1.2148, in which case you will lose $100. However, USD/CDN falls to 1.2118/23. You can now sell $1 US for 1.2118 CDN or sell 1.2123 CDN for $1 US.

Because you entered the transaction by selling US dollars (buying short), you must now buy back US dollars and sell CDN dollars to realize your profit. You buy back US$100,000 at the current USD/CDN rate of 1.2123 for a cost of 121,223 CDN.

Since you originally sold them for CDN$121,380 you made a profit of $157 Canadian dollars or US$129.51 (157 divided by the current exchange rate of 1.2123).