Exposure in finance: meaning, types and examples

Financial exposure is quite a general term, so its meaning can vary depending on the situation it’s being used in. Discover the types of exposure in finance and see examples of how they work.

What is exposure in finance?

Financial exposure is used to describe the potential risk and reward associated with any open position. For example, it can refer to the total value of trades on an asset class or the total possible risk of loss at any given moment.

Exposure can be expressed in different ways too. Some traders will describe their exposure in terms of monetary value, while others will prefer to see it as a percentage of their total portfolio.

For example, if a trader has $10,000 in their account balance, and $100 is in a position on gold, that could also be described as a 1% exposure.

Types of exposure in finance

There are a number of types of exposure in finance, including:

1. Risk exposure – which is the total market value of open positions, and therefore amount at risk, at any given time
2. Leveraged exposure – which is the projected position size of a trade made using a leveraged instrument
3. Market exposure – which describes the total portion of your portfolio assigned to a particular asset class
4. Currency exposure – which refers to how vulnerable a position is to movements in exchange rates

Let’s take a look at each of these concepts in more detail.

1. Risk exposure

When you hear ‘exposure’, it’s usually risk exposure that’s being discussed. It’s the total amount of capital you’ve got in open positions – or the amount of capital ‘at risk’.

For traditional investments, this number is the maximum amount of loss that’s possible. For example, if you’ve invested $1,300 into Amazon shares, then your risk is $1,300 – because the worst-case scenario is that the company’s shares lose all their value.

But risk exposure works slightly differently on leveraged instruments than non-leveraged investments.

2. Leveraged exposure

When you open a position with a leveraged instrument, such as a CFD, future or option, you’ll only need to put down a small initial deposit – known as margin – to receive full market exposure.

For example, if a position’s value is £10,000, but your broker has a 20% margin requirement, you only need to put down £2,000 to open the trade.

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However, your running total will be calculated based on the full value of the trade. This means that your exposure is magnified beyond your margin, which can result in increased profits or losses. In our example, this would be 80% more exposure than the deposit.

To manage leveraged exposure, most traders will choose to use stop-loss orders, which automate the exit of trades to ensure that the risk to a position is limited to known amounts.

3. Market exposure

Market exposure is the portion of a portfolio that is assigned to a particular asset – which could include stocks, commodities, indices or currencies – industry, or geographical location.

For example, if a trader has a £50,000 portfolio, with £10,000 worth of FX trades open, they have a 20% market exposure to forex. If they have £5,000 on a FTSE 100 trade, they have a 10% market exposure to indices. This means they stand to make or lose more based on the performance of currencies than stock indices.

Alternatively, if you look at an investor who has a shares portfolio worth £100,000, £30,000 of which was invested in Tesla and £20,000 in Rivian, they have a 50% exposure to the electric vehicle industry – or a 30% exposure to the US stock market, and 20% exposure to Australian stocks.

What is exposure in forex trading?

Exposure in forex trading is the amount of money a trader has currently spent on opening positions on currencies.

When trading forex, it’s important to remember you’ve got exposure to not one but two different assets, as currencies are always traded in pairs. This means that you need to be aware of any factors that impact both countries’ monetary value.

For example, if you’re trading EUR/USD, you’d have exposure to fluctuations in the euro and the US dollar. So, you’d need to be aware of changes to economic policy from the European Central Bank (ECB) and Federal Reserve, as well as any major political events and news impacting the economies.

What is exposure in the stock market?

Exposure in the stock market is the total amount of capital you currently have assigned to open positions on company shares. It doesn’t matter whether those traders are long or short, it’s the amount of your funds that are tied up and unavailable to use until you close the position.

For example, if you have $1000 worth of Apple shares, $5000 worth of Amazon shares and $2000 worth of Tesla shares, you have a total stock market exposure of $7000. If you then sold $1000 worth of Amazon shares, your total exposure would be reduced to $6000. 

4. Currency exposure

Currency exposure describes how sensitive a position’s value is to changes in the exchange rate between two countries. It’s also known as currency risk.

It comes about as currencies are constantly fluctuating as one appreciates or depreciates in value against another.

This type of exposure is more relevant to securities trading – whether that’s stocks, ETFs, or bonds – but applies to any asset that’s denominated in a currency other than the trader’s domestic currency. The greater the exposure to foreign assets, the greater the currency risk.

For example, if 10% of a US-based trader’s portfolio is allocated to UK stocks, then 10% of the portfolio is at risk of decreasing in value based on fluctuations in the GBP/USD exchange rate.

How to manage exposure in trading

There are a few different ways to manage your exposure in trading. Two popular methods include:

1. Diversification

Diversification is the practice of varying the positions you take so that your exposure to a single asset, industry or geography doesn’t have a disproportionate impact on your total capital.

For example, if you have £1000, of which all £1000 is spent on a short position on gold, then if gold increased in value, all of your capital is at risk.

However, if you diversify that £1000, putting £400 into the short gold position, £200 into a position on a company’s shares, £200 into an index and £200 into bonds, that initial gold trade won’t wipe out all of your capital if it went wrong.

2. Hedging

Hedging is a risk management strategy that involves opening multiple positions to offset, or reduce as much as possible, the risk of loss to an existing trade.

For example, if you have a long position on oil worth $10,000 but you thought it would fall in the near term, you might open a short position on oil to offset some of the loss to your portfolio.

It’s important to note, though, that while hedging can decrease the initial position’s exposure to loss, opening multiple positions does increase your total capital exposure – and therefore your total risk exposure.