As with any investment, foreign exchange trading involves risk. There are four kinds of risk--exchange rate risk, interest rate risk, country risk, and credit risk. All four are equally important for traders to understand, yet each affects the market in varying degrees.
Exchange rate risk is very simple to understand; it is the risk of your position losing value. For example, if you are betting that the dollar depreciates against the British pound, but the dollar actually appreciates, your position going long on the dollar would have lost value. This is basically the risk of losing value.Interest rate risk is the gap of time in between a spot position and a forward contract. This is due to a difference in maturity dates. Many investors will use both spot and forward positions to hedge against exchange rate risk, but doing so can open the door to interest rate risk. There is a period between different maturity dates where investors are left exposed to exchange rate movements. During this time, investors can gain or lose money due to interest rate risk.Credit risk is the risk you run that the counterparty does not honor his payments. Insolvency is rare and is therefore almost entirely ignored. Many traders go through clearinghouses that guarantee the trades, so there is not much to worry about. Lastly, country risk is the risk a country will intervene and disrupt the natural movements of exchange rates. Japan intervenes probably more than any other country in order to support the yen.
