With leverage, there are numerous advantages for traders: it increases the potential profit alongside the market exposure while reducing the capital required for it. However, leveraging also increases the potential (negative) side of the trade; traders should typically manage their risk and use the risk control that they feel comfortable with.
The level of leverage that is right for you is the one that you feel comfortable with based on your risk appetite and level of trading experience. We suggest you start small with leverage ratios that are on the lower side, and grow your leverage as you can stand more.
Risks
Leverage is a fantastic tool for Forex traders who are keen to boost their chances of a substantial profit above their trading capital – by multiplying the market exposure they can enjoy while also slashing their costs. However, leveraging your trading account also magnifies your losses, leading to potentially ruinous results, so it’s essential that you have a comprehensive knowledge of how to stay in control of your risk. If you take on board the pointers here, you put yourself in a great position to maximise the potential gains of leveraged trading, while guarding yourself from the dangers that await the unwary.
When leverage trading, you are borrowing funds from your broker so that you can have more buying power in a position. For every dollar you put into your account, your broker will lend you $9. If an asset’s price goes against you, and you start getting margin calls, either deposit capital or move to liquidate your trade (close out) before losing more. So, before you pick any amount that you’re comfortable losing, assess and regularly review this risk tolerance while also reviewing changes in market conditions to successfully engage leverage trading.
Benefits
The use of forex leverage offers great potential for profit, more trading opportunities and capital efficiency, but it is important that users understand the associated risks, so they can use leverage effectively, and apply the correct type of risk-management strategies to limit loss.
One of the most attractive benefits of the Forex market is its leverage that allows traders to control larger positions with smaller deposits and increases the percentage of their gains in successful trades while decreasing the losses from unsuccessful ones.
More leverage also can increase the frequency and size of the winning trades to make your deals more profitable. This can be advantageous for new entrants or novice traders. They might not be familiar with all subtleties of the market and trends. But adequate knowledge of current economic news, financial indicators and market developments allow them to decide on a trading strategy and leverage ratios.
Limits
Leverage means you can take a bigger trading position than you otherwise would be able to fund on your own – but if the trades move against you, losses will be magnified, and can potentially wipe out your account balance in one go (andregulators restrict levels of leverage that brokers may make available to retail traders in an attempt to avoid such disaster). You must pay interest on the borrowed funds (also known as margin).
As an example, if you have a $1,000 account size and leverage 1:100, your position could theoretically see you trading $100,000. So, let’s say the market moves against you by just 1 per cent – does a few dollars lost here and there really seem so bad? However, given the leveraged nature of your trading position, even small losses could be compounded significantly. This is why it is important to have a clearly defined tolerance for risk – and, virtually speaking, never use more than 3 per cent of your total account value on any single trade (for anyone starting out, this limit should really be lower). How about one final thing? Whenever possible, trade with as high a leverage ratio as your tolerance allows – higher leverage equates to higher risk and, at the same time, the potential for greater reward . . . and, of course, the risk of greater loss!
Conclusions
Effective leverage trading strategies can be beneficial for forex market players as it improves profitability of the trading efforts and also margin efficiency. In a commodity market, trading can be risky and difficult due to constant fluctuations. In order to prevent major losses, traders must understand potential market fluctuations, identify effective buying and selling patterns, and properly hedge their risks.
Trader X has $10,000 in his account, sufficient for a standard lot of, say, an EUR/USD currency pair. But he might decide that, in order to leverage his deposit, he wants to trade 100 times his original capital. That implies a leverage ratio of 1:100: for every $1 deposited, his broker is willing to lend him another $10 to amplify his position in the market.
With higher position size, he will make more when the market moves in his direction but losses will be correspondingly greater. Traders entering into leveraged trades should start with smaller leverage ratios, and then gradually increase their exposure as they learn and gain experience. Also important is that their exposure is diversified, which will help minimise the risks from leverage trades. They should also be aware of what’s happening in the market.