The Role of Currency Diversification in Managing Forex Risk

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The Role of Currency Diversification in Managing Forex Risk

Forex can be a lucrative market to invest in, but with its high liquidity, risks are inherent too. Your level of acceptable risk affects your trading confidence. You might miss out on potential profit.

You need to think about liquidity and market risk, as well as a currency’s stability. The market natural fluctuates, and diversification helps bolster your forex risk management. With the right strategies you will have the confidence to make more trades and protect your portfolio.

You might wonder about the definition of diversification in the world of forex. How can it help you protect your gains and minimise losses?

Let’s take a look. Our guide to currency diversification will help you to succeed.

What Is Currency Diversification in Forex? 

Currency diversification, as in other areas of investment, is the act of strategically investing in multiple currencies. This helps reduce your risk. Reliance on a limited number of currencies leaves you open to large losses, so spread out your capital to leave your options open.

What Is Currency Diversification in Forex

The best part is forex trading can be easier to diversify than other investments. The research needed to invest in multiple commodities, businesses and sectors takes time. You need be become an expert in stocks, metals and technology, for example, to know ones to invest in.

The knowledge you used to invest in your first forex deals is still relevant to diversification. You have the basics, now it’s time to hedge your bets across the forex market. The principles of foreign exchange remain stable, even as the market fluctuated and evolves.

How Diversification Helps to Protect You

You can monitor forex currencies 24 hours a day 5 days a week. This gives forex an edge over other markets. The liquidity of forex lets you make short or long investments too.

Choosing the right currency pairs is key to diversification. When you choose pairs with the right correlation, you ensure you still profit even if certain currencies drop in value.

Currencies with positive correlation rise and fall together. These are the easiest to invest in, but if you will have fewer backups if once currency falls. Countries with close economic and political ties tend to have more positive correlations.

Negative correlation means one currency rises while the other falls, and vice versa. Trade flows, political factors, and economic stances all affect currency value. Negative correlated pairs help protect your investments – even if one falls, you can profit from the opposite reaction.

Get Started with Diversification

Take a look at the most popular currency pairs. These fall into 3 groups: major, minor and exotic or emerging.  

Major pairs have lower exposure than minor pairs, meaning you have less risk volatile fluctuations. The major group includes GBP/USD, EUR/USD, AUS/USD, NZD/USD, USD/JPY, USD/CHF and USD/CAD.

Get Started with Diversification

Minor currency pairs trade away from USD. Spreads can be wider, and you will have more exposure to risk, but this area of forex remains profitable. The euro, the British pound, the Japanese yen all pair up here.

Exotic or emerging pairs match USD against an emerging currency. This has the highest level of exposure and your risk will be higher, but choose well, and your profits could skyrocket.