Leverage in Forex Market is a risky term for the traders. Any misconception about this can lead traders to blow their accounts. Moreover, a trader with a high leveraged account can earn more than others.
November 27, 2019, | AtoZ Markets – Leverage in Forex market can help you make a huge amount of profit. Leverage means a certain amount of borrowed money needed to invest in something. Any high leverage can be dangerous for forex traders. On the other hand, understanding leverage can increase the profit margin.
What is Leverage in FX Market?
In the Forex market, Leverage is the ratio between the trader’s funds and the size of the broker’s credit. In other words, leverage means the borrowed capital from the broker to increase the potential return. Usually, the leverage in the forex market increased the invested capital several times to allow the traders to trade.
However, the leverage size of every company is not the same. It mostly depends on the trading condition of a forex broker. So, Leverage in the Forex market is a way for a trader to trade with bigger volumes than usual, using the own limited amount of investment.
The involvement of retail trading has been increased in the Forex market due to the margin trading opportunities. Forex brokers provide speculation on the market by credit or leverage for maintaining trading positions. Moreover, you can open an account with one of our registered Forex brokers which will provide you leverage according to your requirement.
Before proceeding to invest in the forex market with Leverage, there are more things to know.
How the Leverage Works in FX Market
Generally, Leverage involves borrowing the money to invest in something. In the forex market, Brokers usually provide that money. Forex trading offers high leverage comparing to the other market. In a sense, with an initial margin requirement, a trader can build and control a huge amount of money.
Calculation of Leverage in Forex
To measure the leverage for forex trading using the leverage formula mentioned below:
Leverage = 1/Margin = 100/Margin Percentage
For example, Suppose you deposited 1% of the total transaction value as margin to trade one standard lot of EUR/USD, which is equivalent to US$100,000. In that case, the required margin would be US$1,000. Thus, your margin-based leverage will be 100:1 (100,000/1,000). For a margin requirement of just 0.04%, the margin-based leverage will be 25:1.
You can use this formula to calculate the margin for all types of instruments.
In the foreign exchange markets, very common leverage is as high as 100:1. With this leverage, you can trade up to $100,000 in value at $1000 investment. Many traders believe that the reason for the high leverage in the forex market is that leverage is a function of risk. With proper money management, traders can control the risk or not take leverage if not required. The cash Forex market is so large and liquid that allows the trader to exit at the desired level easily.
Key Considerations of the Leverage:
- Leverage is a borrowed fund that is used to increase the trading position beyond and not available to the cash balance.
- Forex Brokerage allows the use of leverage through margin trading and the broker provides the borrowed funds.
- Forex traders can use the leverage to profit from small price changes in trading instruments.
- Leverage, however, can bring both profits and losses.
Pros and cons of High/ low leverage
The high leverage creates the opportunity to trade with a bigger lot in the forex market. It is obviously an opportunity for traders to increase the probability of gaining more comparing the trade with no leverage. The forex traders are able to borrow significant amounts of capital so that they can gain even more from successful trades.
However, the ultimate success depends on the capabilities of traders. For new traders taking high leverage will be dangerous. Taking a higher risk and gaining a higher return is the opposite of a coin. If a trader failed to achieve sustained growth, he might lose his money quickly due to taking excessive leverage.
Moreover, taking high leverage for scalping can be more dangerous for traders compared to the swing trading or position based trading. As scalping is a very risky strategy and requires a lot of experience, leverage may put extra pressure on the trader while scalping.
On the other hand, taking lower leverage or taking no leverage at all may force traders to miss the trading opportunities. In simple meaning, a trader with $1000 will take many trades with bigger lots than a trader with only $100$. Therefore, a question rises- What is the right leverage size?
Anyways, it depends on your money management and lot size. Even money management with smaller leverage can blow out the investment of a trader.
However, there is no ultimate structure of how much leverage a trader should use. There are some recommendations only:
- Poor money managment+ High Leverage= Blow the Account
- Poor money managment+ Low Leverage= Survive but ultimately Blow the Account
- Good Money Management+ High Leverage= Achieve the fastest Growth
- Good Money Management+ Low Leverage= Steady growth
What is Leverage Risk?
Traders struggle to find how to make the best use of their capital based on the risk tolerance and willingness to use the borrowed funds. With the more leveraged position. A trader can earn more potential profits with a greater risk of loss.
For traders, leverage is much of an issue. However, because traders tend to assume higher levels of risk than investors, their leverage risk remains greater as well.
However, leverage means much greater dollar value to loss comparing to the potential profit. This is a reality of the traders. Many traders use some basic tools such as margin accounts to keep the risks low.
Leverage risk for traders based on maximum margin can force them to lose twice as much in exchange for the potential of gaining. Before creating any maximum margin positions, it is important to determine the risk.
Is high leverage good for beginner traders?
High leverage means lesser money is needed to open per size trade with more free margin available.
Forex markets are the safest of all the markets. Unlike stock markets, Forex markets are good places for trading. Countries don’t become bankrupt; as a result, values of currencies do not go to zero. However, many beginner traders things that forex trading is a quicker way to make money. Therefore, they trade with extremely high leverage to earn a huge amount of money. Unfortunately, most of them fail in this field than successful people.
High leverage trading is extremely prohibited for beginner traders. As it is associated with higher risk, any wrong decision can lead to a financial loss. On the other hand, Forex trading is not that simple that the beginner trader thinks. Understanding the market context is the key to be a successful trader.
- You can make a huge loss of money if a trade works against you. So, you need to handle trading as a business. Trading in the forex market with high leverage risks is like gambling.
- It can be very risky for beginners to use high leverage as they don’t have enough experience in trading with high leverage. So, they may lose all the invested capital. They should not trade with it unless getting a clear idea of how it works.
- The best trader detaches himself from emotions for his trading activity. Too much leverage can push the trader to be excited and expect a strong desire to get a huge profit. In that case, an emotional trader is more likely to be a loser. In the case of forex trading, you should only use the brain, not emotions. Therefore, you should think 10 times before trading with high leverage forex.
How to manage the Leverage Risk
So, leverage can increase potential profits. There is a possibility to increase potential losses as well. Therefore, you should choose carefully how much leverage you need for trading. Moreover, trading in the forex market requires careful risk management. Many traders always trade with high leverage to increase potential returns.
However, It is possible to avoid the leverage risks on trading results. First of all, it is not wise to trade with the whole balance
There are more…
Forex brokers usually provide many risk management tools such as stop-loss orders to help traders to manage risks effectively.
Here are the basic points for leverage risk management:
- Using trailing stops,
- keeping the lot size small
- Limiting the risk of a single trade
So, traders can use forex leverage with proper management to ensure the maximum profit. Keep in mind that the leverage is customizable for the trader’s needs and choices.
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