Forex is a risky Business

Although every investment involves some risk, the risk of loss in trading off-exchange Forex contracts can be substantial. Therefore, if you are considering participating in this market, you should understand some of the risks associated with this product so you can make an informed decision before investing.

As stated in the introduction to this topic, off-exchange foreign currency trading carries a high level of risk and may not be suitable for all customers. The only funds that should ever be used to speculate in foreign currency trading, or any type of highly speculative investment, are funds that represent risk capital – i.e., funds you can afford to lose without affecting your financial situation. There are other reasons why Forex trading may or may not be an appropriate investment for you, and they are highlighted below.

In Forex you are trading substantial sums of money, and there is always a possibility that a trade will go against you. There are several trading tools that can minimize your risk, yes, but eliminate it, no. With caution, and above all education, the Forex trader can learn how to trade profitably and minimize loss.
The Scams and fraud

Forex scams were fairly common a few years ago. The industry has cleaned up considerably since then. Still, you should exercise caution before signing up with a Forex broker by checking their background.

Reputable Forex brokers will be associated with large financial institutions like banks or insurance companies, and they will be registered with the proper government agencies. In the United States, brokers should be registered with the Commodities Futures Trading Commission or a member of the National Futures Association. You can also check with your local Consumer Protection Bureau and the Better Business Bureau.
The market could move against you

No one can predict with certainty which way exchange rates will go, and the Forex market is volatile. Fluctuations in the foreign exchange rate between the time you place the trade and the time you close it out will affect the price of your Forex contract and the potential profit and losses relating to it.
You could lose your entire investment

You will be required to deposit an amount of money (often referred to as a "security deposit" or "margin") with your Forex dealer in order to buy or sell an off-exchange Forex contract. As discussed earlier, a relatively small amount of money can enable you to hold a Forex position worth many times the account value. This is referred to as leverage or gearing. The smaller the deposit in relation to the underlying value of the contract, the greater the leverage. If the price moves in an unfavorable direction, high leverage can produce large losses in relation to your initial deposit. In fact, even a small move against your position may result in a large loss, including the loss of your entire deposit. Depending on your agreement with your dealer, you may also be required to pay additional losses.
You are relying on the dealer's creditworthiness and reputation

Retail off-exchange Forex trades are not guaranteed by a clearing organization. Furthermore, funds that you have deposited to trade Forex contracts are not insured and do not receive a priority in bankruptcy. Even customer funds deposited by a dealer in an FDIC-insured bank account are not protected if the dealer goes bankrupt.
There is no central marketplace

Unlike regulated futures exchanges, in the retail off-exchange Forex market there is no central marketplace with many buyers and sellers. The Forex dealer determines the execution price, so you are relying on the dealer's integrity for a fair price.
The trading system could break down

If you are using an Internet-based or other electronic system to place trades, some part of the system could fail. In the event of a system failure, it is possible that, for a certain time period, you may not be able to enter new orders, execute existing orders, or modify or cancel orders that were previously entered. A system failure may also result in loss of orders or order priority.
You could be a victim of fraud

As with any investment, you should protect yourself from fraud. Beware of investment schemes that promise significant returns with little risk. You should take a close and cautious look at the investment offer itself and continue to monitor any investment you do make.
Types of Risks

Even through you are dealing with a reputable broker, there are risks to Forex trading. Transactions are unexpected and depend on volatile markets and political events.

Exchange Rate Risk: refers to the fluctuations in currency prices over a trading period. Prices can fall rapidly unless stop loss orders are used.

Interest Rate Risk: can result from discrepancies between the interest rates in the 2 countries represented by the currency pair in a Forex quote.

Credit Risk: is the possibility that 1 party in a Forex transaction may not honor their debt when the deal is closed. This may happen when a bank or financial institution declares insolvency.

Country Risk: is associated with governments that may become involved in foreign exchange markets by limiting the flow of currency. There is more country risk associated with "exotic" currencies than with major countries that allow the free trading of their currency.
How to limit risks?

There are some ways to limit risk and financial exposure. Every trader should have a trading strategy; i.e., knowing when to enter and exit the market, and what kind of movements to expect. Developing strategies requires education, which is the key to limiting risk. The basic rule which trader follows aal time: Never use money that you cannot afford to lose.

Every Forex trader needs to know at least the basics about technical analysis and how to read financial charts. He should study chart movements and indicators and understand how charts are interpreted.
Stop-Loss Orders

Even the most knowledgeable traders, can't predict with absolute certainty how the market will behave. For this reason, every Forex transaction should take tools to minimize loss.

Stop-loss orders are the most common way to minimizing risk. A stop-loss order contains instructions to exit your position if the price reaches a certain point. If you take a long position (expecting the price to rise) you would place a stop loss order below the current market price. If you take a short position (expecting the price to fall) you would place a stop loss order above the current market price.

Stop loss orders can be used in conjunction with limit orders to automate Forex trading.