Foreign exchange trading can be very risky for investors. Since there are so many factors, both political and economic, that affect currency movements, it is virtually impossible to predict drastic changes in rates. Investors should be aware of foreign exchange risk before they invest.
There are four main risks associated with currency trading--exchange rate risk, interest rate risk, credit risk, and country risk. The risk that most investors are not familiar with is country risk. Country risk can be hard to determine since it's hard for many investors to fully grasp the economic and monetary policies of foreign governments.Country risk refers to a foreign government forcibly manipulating the rate at which its currency exchanges. A government would manipulate currency values if there is a war, a currency shortage, a tightening of monetary policy, or other necessary events. For example, China is an example of a country that has a large amount of country risk.Since China pegs its currency against the U.S. dollar, the Chinese government might step in and make adjustments whenever its currency price deviates beyond what is considered acceptable. If China steps in and manipulates its currency price and you're on the losing side of that transaction, you're investment position is seriously compromised. Currency futures are usually exempt from country risk because futures markets are predominantly located in the U.S. As an investor, you should take time to learn about the various risks before making currency investments.
