Forex

• To understand how an investor encounters risk in the Forex market, you must understand what a Forex transaction is. To buy Japanese yen, you must sell American dollars or whatever your home currency is. This pairing of one currency with another for trading purposes lies at the heart of foreign exchange. As in the stock market, one side or the other of the currency pair might suddenly gain or lose value in relation to the other. This is what creates a profit or loss in the investor's portfolio.
  
  

Risk

• Just like investing in a company, a person investing in the Forex market leaves himself subject to drastic fluctuations in currency value while he has an open position. Since many investors take advantage of the high amount of leverage, when compared to stock markets, allowed in Forex, a sudden rise or fall in price can be magnified and quickly wipe out a trading account or at least seriously damage it. An investor trading without proper stop losses in place, or one who has poor money management techniques, could find his positions suddenly liquidated by his broker.
  
  

Hedging

• Hedging is a financial instrument that can be used by investors to protect themselves against risk while trading the Forex market. Risk is inherent in this market; to realize a level of profit, you have to take some sort of financial risk. Choosing to employ a hedging strategy might allow you to sleep more soundly at night.
  
  

Types

• The two main types of foreign exchange hedges are forwards and options. Hedging is like an insurance plan. Buying them either locks in a currency's price at a certain level or allows the investor to exercise a deal at a more profitable price at some point in the future if she so chooses -- a sort of last wall of defense against apocalyptic price movement. The downside is that such protection has a price attached that must be weighed against the potential upside of the deal. At some point, the cost of hedging eats away too much profit and becomes counterproductive.