Introduction to Forex Risk Management - Literature review Example

?Order 511052 Foreign exchange market (Forex) is an avenue where investors of international trade and investment convert one currency to another currency. Less knowledge on how the foreign exchange market operates lead to loss, thus how forex risk management is done is the locus of this essay (Levinson, 2005). About Forex Forex is an over-the counter financial market where currencies, worldwide, is traded. It centers, with offices all parts of the world, is a platform where all nationals buy and sell currencies (Levinson, 2005). The financial markets fundamental function is price setting like valuing gold or shares of stock but however relies on the prices whence an individual likes to buy and sell them (Levinson, 2005). The market also does asset valuation, arbitrage, raise capital, commercial transactions and invest in bond, stock or money. Besides, all these, the market also does forex risk management (Levinson, 2005). Forex has four interdependent spot markets where currencies are traded. These are the spot market, futures market, option market and derivatives market. Most of the time, these markets are availed by key actors in direct and indirect investments, such as, exporters, importers, investors, speculators, and governments. Trading is often done at interbank markets and financial institutions although the most common currency traded is the US dollars. Exchange rates are managed either in fixed rate, semi-fixed systems, and floating rates. Forex Risk Management Forex risk management is basically protecting a foreign currency from losing value against the domestic (Levinson, 2005) “currency before an export payment is received as well as enabling markets to attach price to risk, permitting firms and individual to trade risks until they’d hold to what they wanted to retain” (Russell, 2011). Forex risk management is a protectionist system that also contributed to the increase of financial movement in the market in late 1990s after the financial crisis hit worldwide (Russell, 2011). The market actors have maximized all measures to deter negative impact in the currency trade by “innovating derivatives and asset-backed securities to redistribute risk.” Investors these days can now make an option what to bear and use as financial instruments to shed unwanted risks. Investors, either individual or institutional, who are motivated to and to gain capital are assured of this market’s system of resiliency in risk management (Russell, 2011). This is further supported by the institutionalization of formal markets where investors can immediately raise capital by selling shares at the stock exchange (Russell, 2011). The foreign exchange is a huge trading market that is geographically dispersed and exchanges could either be favorable or not depending on the measures of risk management employed otherwise it can be limiting “trade lot size, hedging, trading only during certain hours or days, or knowing when to take losses”(Milton, 2011). Forex trading may seem easy, but in all honesty so difficult, indeed. Traders would either experience sudden corrections in currency exchange rates; bewildering variations in exchange rates; susceptibility to market’s rapid change for profit opportunities; lost payments; delay in the confirmation of receivables and fees; discrepancy of bank drafts received and the contract price ”(Milton, 2011). Tools for Forex Risk Management How should a trader control his loses? Expert in trading currency suggested that investors should think twice to set limits on potential “pressure or drawdown” one is willing to stake in trading. They also advise make use of “correct lot sizes and to start at lower amount depending on one’s level of risk tolerance (Easy Forex, 2011). But for experts, the best rule is to utilize small account balance. They also advised tract “overall exposure” to be abreast of the developments and correlation of currency pairs (Easy Forex, 2011). Gain complete risk control and define your opportunity when the right time presents. Forex professional also exercise due diligence of limiting risk (Easy Forex, 2011). Other trader use calculated risk reward ratio and considered this as effective risk management in Forex trading to gain leverage. Risk reward ratio is perceived as a calculation of maximum risk and rewards in a specific trading date. Trader must determine how much he or she is willing to loss and how much he intends to gain. It is either 1:2 or 1:6 or higher than that (Easy Forex, 2011). But if minimum requirement is not met, the trader should not gamble to trade. It is essential that one must exercise caution to protect one’s account in an uncertain and fluid market. Hence, it is indeed necessary for traders to be truly knowledgeable with typical foreign exchange risks; of “hard currency”; in diversifying investments and utilizing “hedging strategies” (Easy Forex, 2011). Diversification permits trader to neutralize risks of keeping currencies that “deteriorates in value” and instead make use of currency with competing or gaining value (Easy Forex, 2011). This is feasible for business sectors who are conducting several businesses in various countries. As such, one can “convert profits into separate foreign currency reserves and/or coordinating cash flow with basic hedging strategies are ways to achieve diversification” (Easy Forex, 2011). Other introduced tools for risk management like employing VT Trader™ to decide in behalf of the trader to decide a limit and stop of orders while one isn’t attending the market’s development (Easy Forex, 2011). Anent to this is also a tool dubbed as Trader's Guardian that will analyze, evaluate and interpret, in behalf of the trader, the risk exposure in the market. The tools have a Margin Use Level(s) and a Warning Level that is visible at all times (Easy Forex, 2011). Possible exposure can also be tracked in different currencies using the Instruments Exposure and Currency Portfolio tools.  There is also a tool named Trader’s Range as an easy way to “minimize the costs associated with missing an entry or exit on a position, during an extremely fast moving market” (Easy Forex, 2011). Still others avail of Bundled Entry Orders that permits setting of limits and stops for pending position as well as “stop order at preset level thus, limiting your losses” while a number also make use of forex brokers to manage their investment and exact leverage. Conclusion Forex risk management intends to “preserve the value of currency inflows, investments and loans, while enabling international business compete abroad” (Bredin and Hyde, 2004). Risks can’t be feasibly eliminated, but as trader, bad outcomes of forex can be predicted and effectively managed. The trader must determine his trading strategy, control and flexibility when market either “take a profit or cut your losses” (Bredin and Hyde, 2004).   Successful currency traders utilize informed decisions and target the “right time” in making money from foreign exchange markets. REFERENCES Levinson, Marc (2005). Guide to Financial Market. The Economist. 4rth Ed. New York, USA. John Russell (2011). Introduction to Forex Risk Management. Forex Risk Management Basics http://forextrading.about.com/od/riskmanagement/a/risk_management.htm. Accessed March 12, 2011. Adam Milton (2011). Calculating One Percent Risk. About.com http://daytrading.about.com/od/daytradingbasics/qt/OnePercentCalc.htm John Russell (2011).Get Started with Forex Trading. About.com. http://forextrading.about.com/od/gettingstarted/a/Start_trading.htm Easy Forex (2011). Forex Risk. Management Strategies. Risk Management Tools. Capital Market. Services, LLC. New York. http://forex.easy-forex.com.au/learn_fx_trading/forex_trading_tips/risk_management.asp Don Bredin, Stuart Hyde (2004). FOREX Risk: Measurement and Evaluation Using Value-at-Risk Journal of Business Finance & Accounting Volume 31, Issue 9-10, pages 1389–1417, November 2004 DOI: 10.1111/j.0306-686X.2004.00578.x Read More