Risk is inevitable in any financial market, in the foreign exchange market in particular. It is impossible to escape it entirely; however, it is possible to minimize it. And sensible forex traders should be aware of the instruments which help to achieve this.
There are a number of levels of risks characteristic of foreign investments: they include taxation risk, political risk and currency risk.
Taxation risk is significant for the foreign investments in a way that foreign taxation creates quite a difficulty for the forex traders. It means that foreign investors are taxed according to the securities based in the foreign countries. Foreign investment taxes are usually exacted in the source country sooner than the investor can understand the gains he/she has made. Later the profits are subject to taxes once more in the investor’s home country.
Political risk includes the political climate in the foreign countries where a trader or investor makes investments. Portfolio risk is created by the foreign political climate, since political systems and governments are changing permanently. This fact influences economic and business spheres straightly and considerably. It is considered that political risk can be avoided if the investor makes investments in many various countries in addition to having exchange-traded funds and foreign mutual funds (this is called diversification).
Currency risk is the last but not the least, but, on the contrary, one of the most important ones. Foreign investments are directly influenced by the currencies’ value fluctuations, and fluctuations definitely have an impact on the investment risks. Some risks appear to work in foreign investor’s favor, but some don’t. For instance, a certain investor’s portfolio can bring 10% rate of a year return, but his/her domestic currency has depreciated in 5% of its value. In this case an investor’s total return will be even greater in converted in the domestic currency, since decrease in the home currency value make foreign investments more lucrative. However, the opposite will be true as well: if the foreign stock falls but the domestic currency’s value rises considerably, this reduces the foreign position’s returns.
On the whole, risks in foreign investments are something that all forex traders and investors want to avoid as much as possible at the same time increasing the net profit. It is possible to achieve this being aware of the instruments that allow leveraging the foreign investments risk, of which there is no shortage now.