Welcome to the Forex world. Have you ever heard of leverage? If you read some articles about Forex, you may have found out that beginner traders often use leverage to boost their income. Sadly, some of them don’t fully understand how it works and wreaks havoc on their accounts. To build a successful account, you need to determine when to use it and when to search for other strategies. Uncle Ben once said to Spiderman “With great power comes great responsibility”, and we cannot come with a better quote for how Forex leverage works. For most traders, leverage is a useful tool. Forex brokers offer you this weapon to improve your performance on the market, but you must treat trading as responsible as any other job. Approach the business with respect, and it will pay you back.
What is leverage
You probably used leverage before getting into Forex trading. When? Every time you purchased something and used a credit card.
Most times, people use leverage when they buy a house or a car, and it comes in the form of a mortgage. You get a loan from a bank or another provider and use the home or car as collateral. In this scenario, the term collateral refers to the asset the lender takes if you cannot repay the money. For example, when purchasing a house, the bank provides around 80% of its value. It offers you capital to buy something that costs more than you afford at the moment.
The same principle applies when you trade currencies; a broker provides you capital to place a trade. They lend you money, and the collateral is the value of the currency pair you pick. For example, they can ask you to post 10% on a currency pair that has the total notional value of $1000. The broker will require you to have a minimum sum in your account. With leverage, instead of trading the $100 you have in your account, you borrow $1000 from the broker, and you make a trade with $1100. This strategy allows you to control elevated levels of capital without having the needed funds.
In the Forex world, experts often refer to leverage as margin trading, margin finance or trading on margin. Different brokers offer various degree of leverage, from 1:50 to 1:1000. The higher the leverage your broker offers, the less money you need. When used right, it can boost your potential returns.
Pros and cons with high leverage
Before brokers offered leverage to all their users, only wealthy traders could make high returns, but now, everyone can take advantage of this opportunity. Working with a high leverage broker boosts the capital and offers financial independence.
The brokers that offer their clients leverage don’t ask interest on their funds. Most people are afraid leverage works like mortgage, but they’re not expected to pay interest.
When used right, it can enhance the scope of the profit. For example, when someone has $100 in their accounts, they can make trades with $100.000. The higher the sum they trade, the higher the profitability.
But as with any other business, with higher investments, the heavier the losses. When collaborating with a Forex broker that offers high leverage, it’s essential to research and pay attention to the movements of the market. Base your predictions on facts and studies to prevent losing your savings. Some brokers set margin requirements when they lend money. Depending on your capital, they’ll ask you to fulfil a specific transaction size. When you fail to meet their demands, they can liquidate your portfolio.
How to choose the best leverage level
Now that you know how leverage works and how you can benefit from it, you may wonder what ratio you should choose. Sadly, there’s no general answer to this question because a myriad of factors influences it. To name a few, your trading strategy and the upcoming market moves have the most significant impact. Breakout and scalper traders usually opt for brokers with high leverage because they look for quick earnings. Positional traders, on the other hand, prefer brokers with low leverage.
What leverage is the right one for you? Pick the ratio that makes you comfortable. On the market, you’ll find entities that offer from 1:1 to 1:1000. For example, when you have $1000 in your account, and you work with a broker that provides 1:100 leverage, you can trade with sums as large as $100.000. But do you feel comfortable to do it?
How to manage leverage risk
Trading Forex is similar to running a business, so you need to learn how to manage risk. Leverage can boost your potential income, but it can also increase the losses, so it’s wise to select the amount of leverage carefully. The traders who use it to enhance the return on their investment are aware that they need to come up with a risk management strategy if they want to prevent account collapse.
When planning carefully, you can avoid adverse effects on your trading results. Firstly, and most importantly, you should never trade the whole balance at once. Only because a position seems attractive, it doesn’t mean you need to open it with your maximum trading volume, especially if you’re a beginner.
It would be best if you also used risk management tools like stop-loss orders to control the sum you can lose. You can find online directories that provide information about the tools expert traders use to create trading strategies and manage their operations. When you create a risk management strategy use trailing stops, keep the positions as small as possible, and use limited capital for each job.
With proper management, you can use Forex leverage to increase your earnings and even make a living from trading alone. Brokers provide it because they want to encourage you to explore the benefits the market offers. But before picking the amount, check the reliability of the broker and its conditions. As with any other business tool, leverage works like a double-edged sword, and it can generate gains as long as you know how to use it.
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