Risks of Forex Trading - FX Risk Management - City Index UK (2024)

Reviewed by Patrick Foot, Senior Financial Writer.

  • What are the forex trading risks?
  • How to practise forex trading risk-free
  • How to manage risk in forex trading
  • Stop-loss and take-profit orders
  • Making a trading plan
  • FAQ

Risk in forex tradingis the same as risk in any other market. If your positions go against you, you may have to close them at a loss instead of a profit.

No trader gets it right 100% of the time, so learning how to manage and mitigate risk is a key part of achieving success. In this guide, we’re going to cover the forex trading risks you should be aware of, and how to keep them in check.

What are the risks of forex trading?

There are two main risk factors that come with forex trading: volatility and margin. Let’s examine what each is in turn, before we take a look at how to mitigate them.

1. Volatility

As we covered on the what is forex tradingpage, currency prices are constantly on the move due to the high liquidity of the foreign exchange markets.

High liquidity is usually a good thing – it makes it easier for you to find someone to trade with, so you can quickly get out of trades. But when it leads to high volatility, it means that markets can make big swings. These swings could work in your favour, or they could amplify your losses.

As with any market, greater potential profits come with greater risk. Highly volatile forex markets bring just that. They’re prized by some traders, but can hurt your bottom line if you’re not careful.

2. Leverage

Whether you decide to trade via spot forex, FX CFDs or spread betting on currencies, chances are you’ll use margin to open your positions. Without it, you might have to spend hundreds of thousands of dollars, pounds or euros whenever you want to trade.

Margin means you only need a fraction of your trade’s full value in your account to open a position. Many of City Index’s FX marketsonly require 3.33% or 5%. Your profit or loss, though, will still be based on the full value of your trade, which magnifies both your profits and your losses.

Margin example

Say you spread bet £5 per point on EUR/USD at 1.1850.

The total value of your trade is (5 * 1.1850) £59,250, but you only need (3.33% of 59,250) £1,973 in your account as margin.

EUR/USD moves up 50 points, making you £250. You’ve made £250 from £1973, a 12.7% profit. If you’d had to pay the full £59,250, you’d still have made £250 – but that’s only a return of 0.42%.

The same would have happened if Eurodollar moved down 50 points. You’d lose £250 from an initial deposit of £1,973, instead of £59,250. Leverage has magnified your loss.

How to practise forex trading risk-free

There’s no such thing as a risk-free forex trading strategy, but you can practice buying and selling currencies with zero risk. A City Index demo accountgives you £10,000 in virtual funds, and access to our full range of FX markets.

If you want to see how successful you’d be on live markets, it’s the perfect place to start.

Try a City Index demo.

How to manage risk in forex trading

There are lots of different strategies and tools you can use to limit your forex trading risk. Here, we’re going to explore two: using stops and making a trading plan.

Want to find out more about managing risk? Head over to the City Index Academy.

Stop losses and take profits

Stop losses and take profits are orders that tell your trading provider to close a position once it hits a certain level. Stops close it once it reaches a set amount of loss, take profits close it once it reaches a set level of profit.

You’ll also often see take profits referred to as ‘limits’.

Stops provide a useful method of deciding your overall risk on any trade. For example, if you want to bet £5 per point on GBP/USD but only risk £300, you can use a stop.

Your cable position will make or lose you £5 for every pip that the pair moves, so if you place a stop 60 pips below the opening price of your trade, it will close the position if it hits a £300 loss.

Risks of Forex Trading - FX Risk Management - City Index UK (1)

Take profits, on the other hand, can help you set profit targets. If you’re aiming for a £900 profit from your GBP/USD trade, you can place a limit 180 pips above your opening price.

Guaranteed stop loss orders (GSLOs)

Stops will always execute at the best available price, which might not be the same as your chosen level. If your market gaps over your stop, for example, your trade will close at the first price available after the gap.

GSLOs prevent this, always executing at the level you set. To upgrade a stop to a GSLO, you’ll pay a small premium.

GSLOs are available with a live City Index account.

Tips for placing stops

1. Strike a balance

You might be tempted to set your stop as close to the market’s opening level as possible, to limit your potential losses from the trade. However, this will increase the likelihood of your stop being triggered.

Pay attention to current market conditions and try to strike a balance between giving the position room to move and risking too much capital.

2. You can move stops

Your position has moved in your favour, and you think it has further to run – but you’re worried about losing your profits if the market reverses. Instead of closing your trade, you could move your stop up to secure your profits now.

You can even set trailing stops. These will automatically follow your market if it moves in your favour. Then, if it turns, your stop remains in place.

3. Look for support or resistance levels

Applying technical analysis can be useful when deciding where to place your stops.

Say, for instance, that you’re considering selling EUR/USD at 1.1502. Looking at a EUR/USD chart, you notice that Eurodollar has previously moved up to 1.1540 multiple times but struggled to break beyond it.

If EUR/USD moves past 1.1540, a longer rally might be on the cards, so you know your planned short trade has failed. Place a stop just above 1.1540, and you won’t suffer any further losses.

Want to practise placing stops? Get started with a free City Index demo.

Creating a forex trading plan

Planning your strategy beforehand is crucial to limiting your risk. Otherwise, emotions can lead to bad habits in the heat of the markets.

Your trading plan should include how much to deposit into your account, and your accepted risk on each trade – including your risk/reward ratio.

Trade sizing is key to achieving this. If, for instance, you decide to risk 10% of your account on each position, then it will only take ten losing trades to clear your balance. Drop your risk to 2%, and that number goes up to 50.

Margin calls

What happens if you don’t have enough funds in your account to cover your margin? You’ll be placed on margin call, and we might automatically close your positions to lower your margin requirement.

Your risk/reward ratio, meanwhile, dictates which opportunities you trade, and which you skip. Essentially, you’re deciding how much potential profit you need in return for the capital you’re risking.

A ratio of 1:2 means that you target twice as much profit as loss. Set a stop loss 100 points away, and you’d want a take profit 200 points away.

You should make double the profit from successful positions as losing ones, which means you don’t have to be right more than 50% of the time to earn a profit.

Find out more about creating a forex trading plan.

Risks of Forex Trading - FX Risk Management - City Index UK (2024)

FAQs

What is the biggest risk in forex trading? ›

What are the risks of forex trading? There are two main risk factors that come with forex trading: volatility and margin. Let's examine what each is in turn, before we take a look at how to mitigate them.

What is the best risk management in forex? ›

How to manage risk in forex trading
  • Understand the forex market.
  • Get a grasp on leverage.
  • Build a good trading plan.
  • Set a risk-reward ratio.
  • Use stops and limits.
  • Manage your emotions.
  • Keep an eye on news and events.
  • Start with a demo account.

Is TradingFX safe? ›

Avoid Tradingfx Global as it is not regulated by a top-tier regulator. The first rule of keeping your investments safe is to avoid brokers that are not regulated at all. Having said that, the fact that a broker is regulated is not sufficient to guarantee the safety of your money.

Which of the following is a risk associated with forex trading? ›

Transaction Risk

This is one of the main risk factors in forex trading and is contingent on exchange rate changes. Since forex trading is active round the clock, exchange rates are subject to change before a trade settles.

Why 90% of forex traders lose money? ›

Most traders fail because they do not invest enough time and effort in learning about the markets and trading strategies. They enter the market without a proper plan or strategy, which leads them to make poor decisions and lose money.

What is the dark side of forex trading? ›

Forex scam risk involves the danger of engaging with fraudulent brokers or falling victim to investment scams promising unrealistic returns. These scams can lead to significant financial losses and erode trust in the Forex trading environment.

What is the safest forex trading? ›

A safe broker will be regulated by a reputable financial authority, have a good track record, offer competitive trading conditions, and have a strong customer support team. Some of the safest forex brokers in the world include Pepperstone, IC Markets, FXCM, OANDA, FBS, XM, eToro, AvaTrade, IG, Saxo Bank, and FXTM.

What are the three types of forex risks? ›

There are three main types of foreign exchange risk, also known as foreign exchange exposure: transaction risk, translation risk, and economic risk.

What is 2% risk management in forex? ›

Risk per trade should always be a small percentage of your total capital. A good starting percentage could be 2% of your available trading capital. So, for example, if you have $5000 in your account, the maximum loss allowable should be no more than 2%. With these parameters, your maximum loss would be $100 per trade.

Should I invest in forex trading? ›

Forex trading may make you rich if you are a hedge fund with deep pockets or an unusually skilled currency trader. But for the average retail trader, rather than being an easy road to riches, forex trading can be a rocky highway to enormous losses and potential penury.

Is FX Option legit? ›

Let's find out. Fx Trade Options is not a trusted broker because it is not regulated by a financial authority with strict standards. We would not open an account for ourselves with them. If you want to stay safe, only sign up with brokers that are overseen by a top-tier and stringent regulator.

Is SecureFX trading legit? ›

No. SECURE TRADING FX is not a good choice for beginners. Not only because of its unregulated condition, but also because of its inaccessible website.

Why is forex trading risky? ›

In forex trades, spot and forward contracts on currencies are not guaranteed by an exchange or clearinghouse. In spot currency trading, the counterparty risk comes from the solvency of the market maker. During volatile market conditions, the counterparty may be unable or refuse to adhere to contracts.

What is toxic trading in forex? ›

Toxic traders employ strategies that exploit inefficiencies or imbalances in the market to gain an unfair advantage. Common toxic trading behaviors include: 1. Latency Arbitrage: Exploiting the time lag between price feeds to profit from price discrepancies.

How to spot a forex scammer? ›

Here some key factors and red flags to look out for:
  1. Qualified Fund Managers. Establish that the fund managers are qualified and experienced. ...
  2. Inflated Returns. Scammers often claim massive historical returns and will show numbers that way exceed market norms to lure investors in. ...
  3. Excessive Management Fees.

What is the maximum risk in forex? ›

Risk per trade should always be a small percentage of your total capital. A good starting percentage could be 2% of your available trading capital. So, for example, if you have $5000 in your account, the maximum loss allowable should be no more than 2%. With these parameters, your maximum loss would be $100 per trade.

What is the biggest risk in trading? ›

However, just because risk is a fact of trading life, doesn't mean you can't limit the financial risks you're exposed to and how much loss they signify. There are three main categories of risk every trader is exposed to - market risk, liquidity risk and systemic risk.

Is forex Riskier than stocks? ›

The forex market is far more volatile than the stock market, where profits can come easily to an experienced and focused trader. However, forex also comes with a much higher level of leverage​ and less traders tend to focus less on risk management​, making it a riskier investment that could have adverse effects.

What is the greatest risk associated with forex settlement? ›

Credit risk is often considered the greatest risk associated with Forex (foreign exchange) settlemen...

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