Veteran and amateur traders alike must understand forex risk management methods if they hope to have any chance of financial success in the long run.

Most traders, if they think of risk at all, only think about market risk. That is how changes in the value of the currency we are trading affect our funds. However there are 5 major types of risk when trading forex and it’s important you understand each of them.

Listed below are the 5 major risks all FX traders must be aware of, and simple strategies to protect yourself from each of them.

Please do not take this as an exhaustive list, nor as a deterrent to trading, it is only meant to help expand your awareness of foreign exchange risk management and prepare you for a long term, profitable run as a forex trader.

The Five Different Types of Risk When Trading Forex

#1. Broker Risk: There is always a small chance that your broker will go bankrupt or otherwise meet their demise.

As you might remember, in 2005 Refco went bankrupt and they were one of the world’s largest investment and brokerage firms involved in forex.

Be sure you do your due diligence when selecting a broker.

#2. Technology Risk: In a trading world run almost entirely on computers, the effects of a hard drive crash, power loss or Internet connection drop out can be drastic.

At a bare minimum you should have daily backups of your computer on a separate hard drive or other backup system. And if you are a serious trader consider investing in a surge protector, power generator and backup dial-up Internet connection.

Some people might laugh at going to these lengths, however anyone who has experienced a serious computer crash knows how devastating it can be, and it could be a lot worse if you were caught in a trade with no way of getting out.

#3 Market Risk: How market changes affect your positions. The most common type of risk people associate with forex.

You can largely eliminate large losses that arise from market conditions by using stop losses and following trading systems with in-built entry points, exit points, and profit targets.

#4. Economic and Political Risks: Political policy changes, major economic emergencies and governing authority intervention can all have an impact on a country’s currency value.

You can avoid these type of risks by using a trading plan that integrates solid foreign exchange risk management methods and identifies issues before they impact your positions.

#5. Country Risk: Finally, there is the risk that a country won’t have the money to meets it’s financial commitments, and will default.

Defaults can have serious effects on many other financial instruments throughout the country, as well as in other countries doing business with that country.

You can avoid these risk by trading only the major currencies and staying clear of emerging markets and countries with serious financial deficits.

I hope it is now clear that the risks involved in trading forex are deeper than the surface market risk most people are familiar with.

Luckily, many existing trading systems have in-built foreign exchange risk management strategies to deal with, and eliminate, many of these risks.

However, even the most sound foreign currency risk management strategies are still not perfect, and there will always be some risk involved when trading. Always use your own best judgement about your risk tolerance levels and never trade above your head.