Potential Dangers in Foreign Exchange

Foreign exchange is very profitable and also it is risky. Multiple traders and numerous sophisticated trading instruments exacerbate these risks in foreign exchange. Knowing foreign exchange risks are vital in managing it.

The shifting of worldwide market supply and demand creates a continuous effect on the foreign exchange market. Such effect can be identified as an exchange rate risk. Spot deals, forwards outright, futures and options in foreign exchange are the ones mainly affected by the exchange rate risk.

Exchange rate risk starts with the foreign exchange traders. What a good foreign exchange trader can do is to cut the losses short and go with profitable positions. Two popular measures to keep foreign exchange losses low are the position limit and the loss limit.

In position limit, foreign exchange trader may be limited to carry a certain currency at any time when regular trading is going on. Another position limit calls for maximum outstanding position kept overnight by foreign exchange traders. Each trader must have an established foreign exchange market limit based on level of trading skill and not by level of seniority or profitability. Each bank and treasury may have rules regarding this. The limits may be held high or low for a set period of time by the senior officer from the treasury to encompass unique foreign exchange market condition.

The loss limit is a way of holding off unsustainable losses by foreign exchange traders. This limit enforced by senior officers on the dealing room is chosen either on daily or monthly basis. This measure is of enormous help for foreign exchange trader because it lifts added pressure on deciding the size of loss to take.

Foreign exchange risk is to be tamed by the management by setting clear rules regarding policies of risk management. The rules must be revised regularly or in response to unusual market development. The management must find the most suited way in dealing with present or projected trading capacity. And it also takes into account the loopholes of these ways so as to come up with a proper risk management policy. Flexibility and sped of adjustment are crucial in fast-changing financial markets such as in foreign exchange.

Position and loss limits are very basic risk management measures. And with the help of control tool, these limits can be implemented better and easily. With the aid of computers, foreign exchange transactions are entered into the system database. The treasury and chief trader can have access continuously, instantly and comprehensively to trading date. Whatever their conclusions, it can then be transmitted to headquarter terminals.