Risks Of Investing In Foreign Currency

Investors need to be very careful and have in their stash, effective risk-management techniques so as to be able to mitigate these risks and yield better returns

The gains that come from investing across foreign waters can be amazing as it helps increase the diversification of your portfolio as well as the total profits or returns on them. This high profit potential is the reason you’ve heard many stories about self-made forex billionaires.

However, just like most success stories, there are many losses and stories of failure behind the success. There are many more people who never even made it to the forefront. The risks of investing in foreign currency goes beyond trading forex.

It also involves investing in foreign stock. Investors need to be very careful and have in their stash, effective risk-management techniques so as to be able to mitigate these risks and yield better returns. For this, investors first need to be able to know the risks:

High Leverage

The use of leverage in the foreign market is very prominent and is carried out by using a margin (an initial investment so as to trade in foreign currencies), especially if you are investing directly.

As such, all the risks of leverage are on full display. When market conditions are unfavorable, investors that take on too much leverage with incur major losses which would now be more than their initial investments. You can lose more money than you invested.

The only real way to mitigate this risk is to have ample capital available so as to be able to avoid the risks that come with using leverage when trading directly.

Highly volatile

Considering the various economies involved, their different political landscapes, the various central banks and so on, high volatility is no surprise. It takes a single currency dropping to a very low value to crash your entire investment.

To invest in foreign stocks as well, you have to exchange the Naira at an exchange rate for that of another currency (the currency of the stock you want to purchase) to purchase the foreign stock. When you want to sell, you also need to convert back to the Naira.

Of course, this isn’t always the case as people have dollar denominated accounts and can story value in foreign currencies. For all forms of currency risks and the volatility they come with, a mitigating method is to hedge your exposure.

You can use currency futures, options, and forwards. You just need to know how to use them well.

Liquidity Risks

When you want to cash out on your foreign stock investments, the natural thing to do is to sell. For this, you must be able to find buyers. Liquidity risk arises when you are unable to sell your stock quickly enough.

You, therefore, need to be able to evaluate the liquidity risk on an investment before you venture into it. A way to spot securities like that is that illiquid assets will have wider bid-ask spread in comparison to others.

Transaction Risks

If you’re investing in forex, then transaction risks should also be considered. Because the foreign exchange market works 24 hours, you need to be conscious of the time differences in one country to another.

If you know anybody that trades forex, then you would have heard about how they stay up on some nights. Exchange rates can generally change before a trade settles. It is this time differential between entering and settling that creates the transaction risk.

Depending on the methods used to invest across Nigerian borders, you can make a huge deal and you can also lose them. However, if you are to take a good position, investing in foreign stocks as opposed to trading in forex would be it as the other risks of trading like timing the market also apply to forex trading.

Investing for the long term is gold.

Written by Lawretta Egba.