Foreign exchange, commonly known as forex, is the trading of one currency for another one. In terms of trading volume, the forex market is one of the largest in the world. The primary objective of a forex trader is to yield a net profit by buying low and selling high.
Forex trading comes with its share of risks and losses. So, how is the exchange rate of a specific currency decided in one of the most liquid global markets in the world? And with trillions of dollars changing hands every day, how is the price associated with each pair agreed upon?
An exchange rate is the value of one currency against another nation or a different economic zone. The forex rates depend on the market’s demand and supply forces or are decided by the country’s central bank. In other words, the rate of a currency is never constant and is always fluctuating. An exchange rate risk is a financial impact caused by changes in the exchange rates between currencies.
Investors are always attracted towards countries with higher interest rates. So, if the interest rate of a country increases, it brings in more investors, giving more value to its currency. On the other hand, if interest rates fall, investors leave, impacting the economy and weakening it. The interest rates of a country have an indirect effect on the exchange rates and the difference between currency values can cause forex prices to change.
The forex market is driven by numerous factors – however, one of the largest drivers of the exchange rate values is central bank interest rates. Important announcements from central bank and economic news play a vital role in interest rate moves and in turn affect FX prices.
Exchange rate risk
Exchange rate risk is a crucial part of international transactions and businesses. This is because the negative exchange rate fluctuations between two currencies can have a significant impact on profit margins.
Exchange rate risks happen because there are continuous and volatile shifts in the worldwide supply and demand of currencies. For example, when a trader’s position is outstanding it can be subject to all price changes. And, unlike regulated futures exchanges where daily price limits are imposed, the off-exchange trading of Forex is largely unregulated.
The exchange rate in swing trading is not completely unnecessary but it can be avoided. These risks can be moderated by implementing certain swing trading strategies as given below:
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Avoid failures of the exchange rate in Swing Trading in the UK
Swing trading is a short-term forex trading style where traders take smaller profits by holding positions for less time - a period between 2 days to 2 weeks, sometimes even up to a month. Swing traders need to stick to these shorter time frames and compound the gains into big profits over time.
To avoid failures of the exchange rate in Swing Trading in the UK, traders need to ensure that losses are kept within controllable limits. Specific risks and commission costs are higher with swing trading when compared to other strategies. Additionally, swing trading is more vulnerable to market volatility and there can be a risk of large losses.
A few common approaches applied in swing trading to minimise losses and increase the potential for return are given below. These commonly used techniques ensure there is a minimal impact or loss in a trade down.
The stop loss
Forex is an unpredictable fast-moving market. The uncertainties of the currency prices makes each swing trade is a risk.
Stop loss is one such function that helps traders to protect their investment against extreme losses in the forex market. The stop-loss helps a trader to buy or sell a currency once a pre-set price threshold is reached. It limits losses in this volatile market by setting a specified stop loss level.
Stop loss is the level at which a trader is willing to see his investment drop down to, thereby restricting the loss subjected to. This is a way of insulating the trade from a big risk and containing the damage in the event of things going wrong.
For example, if you have placed a buy order on EUR/USD at 1.165 and set a stop loss at 1.155 and a target level of 1.175, when the price moves below your entry and hits 1.155 your order is closed for a loss of 10 pips. Likewise, when the price moves to 1.175, your order is closed for a profit of 10 pips.
Below are a few strategies that can be applied when placing stop loss orders.
Static stops: If the stop loss is set at a static price it is known as static stops. Here the trader does not change the stop until the trade either hits the limit price. Static stops are very useful to beginners trying different strategies and trading styles
Static stops based on indicators: A static stop loss can be set based on an indicator such the Simple Moving Average (SMA), Moving Average Convergence/Divergence (MACD), Bollinger band or the Fibonacci retracement indicator.
Trailing stops: Trailing stops are stops that are changed or moved as the trade moves in the trader’s favour.
A limit order is one where a trade instruction is released to buy forex by specifying a price or better than it. This helps identify opportunities to identify a trade and execute it with a set target. Because there is a specific instruction that is set, you do not have to then manually track the price movement and the trade will happen as planned.
A stop order is a strategy that is used to restrict losses. Here, the instruction is to exit a position if the price gets any worse than a threshold that is set. By making a stop order on the trade, a trader successfully reduces the risk of further losses by making an exit plan.
The position limit
In simple words, a position limit is the maximum amount of any currency, established by exchanges or regulators, a trader is allowed to carry, at any single time. The position limit makes sure that the trading risk is kept under control.
A swing trader knows that protecting his capital is as important as making profits. With a focus on risk management, the approach to trading becomes more organised and planned.
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