Leverage in Forex is commonly believed to be high risk because it supposedly magnifies the potential profit or loss that a trade can make. It is the way that an amateur trader looks at forex leverage, and is, therefore, the wrong way. Leverage is actually a very efficient use of trading capital and is valued by professional traders because it allows them to trade larger positions with less trading capital.
Leverage in Forex refers to the percentage of your total position that is from borrowed funds used to magnify your returns. Margin is the actual cash portion of your position; it’s a security deposit set aside from your total account as a provision against loss and the need to repay the borrowed funds. Forex Leverage and margin are just two ways of viewing the amount of borrowed funds used to magnify your gains or losses, your opportunities, and risks.
For example, 100:1 leverage means you set aside a margin deposit equal to 1 percent, $100, of your total $10,000 position. That $100 allows you to control $10,000 of the EURUSD or $10,000 worth of Euros. Using a 50:1 leverage implies a 2 percent margin deposit of $100 that is set aside from your account to control $5,000 of the EURUSD or $5,000 worth of Euros.
Leverage in Forex does not alter the potential profit or loss that a trade can make. Rather, it reduces the amount of trading capital that must be used, thereby releasing trading capital for other trades. For example, a trader that wanted to buy a thousand shares of stock at $20 per share would only require perhaps $5,000 of trading capital, thereby leaving the remaining $15,000 available for additional trades. This is the way that a professional trader looks at leverage in Forex trading, and is, therefore, the correct way.
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Forex Leverage is a dual-edged sword that can work for or against you. The easy availability of leverage in forex is what attracts the risk seekers and repels the risk-averse investor. Forex Leverage is neither inherently good nor bad by itself. Like a car or ﬁrearm, it is easy to learn how to use it safely and effectively if you have enough training, self-control, and common sense needed to wield it without hurting yourself. Those lacking any of the above should avoid it until successful using practice accounts; otherwise, the results will be gruesome.
Understanding of leverage in forex is one of the primary characteristics that separate the winners or future winners from the eternal losers on whom the others can feed.
The reality is that professional forex traders trade using leverage every day because it is an efficient use of their capital. There are many advantages to trading forex using leverage, but there are no disadvantages whatsoever. Trading using leverage allows traders to trade markets that would otherwise be unavailable, like the forex market.
Leverage also allows traders to trade more forex lots or index contracts or shares than they would otherwise be able to afford. However, the one thing that trading using leverage does not do is increase the risk of a trade. There is no more risk when trading using leverage in forex than there is when trading using cash, as long as you control the risk per trade (1 to 3 percent) using a proper position sizing.
Again, the margin in forex is the minimum percentage of the cash value of your position that your broker requires you to set aside for each trade. Forex Margin and leverage are two different aspects of the same feature, reﬂected in how little cash you need to control a 1 forex lot, mini-lot, or micro-lot.
For example, using 100:1 leverage or a 1 percent margin requirement means the same thing in forex trading. You need $100 to control $10,000 worth of a given currency pair, which is one mini lot. Every 1 percent price move would bring a $100 gain or loss. You’d need $500 to control ﬁve lots, and each 1 percent price move would bring a $500 gain or loss.
The higher the leverage or lower the margin in forex, the greater the percent proﬁt or loss for every 1 percent price movement and the greater the reward and risk. Your margin deposit is not your maximum possible loss. Instead, it’s the minimum amount you need to open a position and keep it open. If the price moves against you, your forex broker will automatically set aside more cash and increase your margin deposit to cover that drawdown to in your forex account.
Your maximum loss per trade depends on where you have set your stop-loss order, the size of your position, and whether you had enough cash in your account to cover that loss and any others you may be taking. If you didn’t, your forex broker can terminate some or all of your positions to keep your account from going below zero, via what’s called a margin call.
In other words, the more leverage in forex the better. Professional traders will choose highly leveraged markets over non-leveraged markets every time. Telling new traders to avoid trading using leverage is essentially telling them to trade like an amateur instead of a professional.
Understanding leverage in forex is important, but if you want to learn how to use it, start trading and notice how leverage affects your risk and money management.
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