Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged. The basic need for a Forex market comes from the need to do business across national boundaries. In Forex trading it is useful to understand who is hedging their foreign currency risk and over what time span. More business across national borders requires more hedging of foreign currency risk and increases activity in the Forex market. Forex trading of currency pairs of countries who do a lot of business together will allow you to trade with high volume making your trading software more accurate.
A translation risk is the risk that the Forex market rates will change between writing a contract and final payment. A Chinese ship building company writes a contract for payment in dollars for building a ship. Then the company buys what it needs to build the ship and it pays its workers in Yuan. The value of the Yuan goes up and the dollar goes down. The company ends up losing money on the sale. An American high tech company agrees to pay a Swiss company in Swiss francs for each dosage for use of its patent on a genetically engineered cancer therapy. The franc goes up and dollar goes down. The American company’s payment in dollars by the HMO’s and Medicare is frozen and the company cannot afford to make and sell the drug in question.
The way out of this is to hedge which is to buy and sell currency futures, to deal entirely in the foreign currency, if possible, or to take out a loan in that currency on the day the contract is written and immediately convert to the home currency.
None of the above is what Forex trading on a daily basis is about. On the other hand it is exactly what Forex trading is about. The expectations of very smart people whose job it is to hedge risk for their companies is a large part of what drives currency markets. Having a sense of where the consensus is will give you a better shot at making a profit in day trading.
Even if your Forex trading involves moving quickly in and out of Forex market positions it is essential to know what is driving the Forex market. You are watching your computer screen and, off screen six thousand miles away, someone is buying or selling in your Forex market currency pair to protect a huge contract for shipment of beef to Japan from the USA or coal from Australia to China, paid for in Euros. Although the Forex market is huge at roughly $3 trillion USD a day, it is very liquid. The Forex Market can make abrupt turns. This is where having a sense of what is going on off screen will held wait on a trade or get out when the Forex market makes a big move either with or against your position.