Understanding how leverage works in the forex market is crucial to a successful trading career. Using leverage increases your buying power. It allows you to hold positions worth thousands of times the size of your initial deposit. You can increase your profits by using leverage, but it can also dramatically increase your losses. If you have $100 in your account and 100:1 leverage, you can hold positions worth ten thousand dollars in currency. Obviously, using this strategy doesn’t come in handy; you need to learn the art of using leverage.
Leverage
Leverage is one of the most common terms in the forex market. Leverage allows traders to multiply the amount of money they put into a position. This makes the amount of money they can earn larger, but with this, the risks of the trade also increase. Properly used, leverage can be a forex trader’s best friend.
Leverage in the forex market allows you to buy and sell a currency pair with a high level of buying power. In other words, you can have a hundred-dollar account but hold ten thousand pounds in positions. Leverage magnifies both the profits and losses in a trade. On the downside, it can make trading much more expensive, and the cost of transaction fees can eat into profits. To make the most out of leverage in the forex market, it is necessary to learn how it works and the risks it involves.
The Relationship of Leverage & Risk
In forex trading, the significance of leverage cannot be understated. Forex traders aim to increase their profit potential while reducing the amount of risk. To do this, they use leverage. Leverage is the ratio of funds to the total value of the trading account. Forex leverage is higher than the ratio of 1:2 on equities and 1:15 on futures. Since currency prices move by less than 1% in a single day, traders can absorb losses without losing their entire trading capital.
In forex trading, leverage can be compared to a line of credit. It allows the trader to leverage up his or her trading capital to take profit from small market movements. Since the trader does not have to pay interest or repay the debt, leverage has an important role in forex trading. But it can also cause immense difficulties once it starts working against the trader. Therefore, traders should understand the importance of forex leverage before using it to trade.
Leverage allows traders to borrow money from their forex broker and enter a position that is worth more than the money in their brokerage account. Because leverage is so powerful, it can be a lucrative tool for a trader. It can also help a trader gear their portfolio for greater exposure, but traders should take into consideration the risks involved. When used properly, leverage can make the difference between doubling profits and losing all of your capital.
Making Profits Through Leverage
One of the most popular features of the forex market is the high leverage that can be used to make large profits. The amount of leverage you can use depends on the broker you choose, but in general, you can have up to five times your initial capital. Using this type of leverage is risky; however, so many professionals recommend that you limit your leverage to ten or twenty times. Despite the high risk, this type of leverage has added a lot of excitement to the FX market. Without leverage, a 10% change in the account value would take more than one year, but with it, you could make as much as $500 in just one day.
Traders can benefit from the use of leverage in the forex market to increase their potential profits, but the cost of this strategy must be carefully considered. It can magnify profits and losses and have devastating effects on a trader’s finances if not used correctly.
Maximum Leverage
The maximum leverage in the forex market varies from country to country, but in most cases, it is in the region of one hundred percent. The leverage available for Major Forex Pairs is 30:1, while the maximum for Minor Forex Pairs is 20:1. For the European market, leverage is limited to 1:20 for minor and exotic currencies. This may seem like a lot of money, but it is a necessary evil if you want to make decent profits in the foreign exchange market.
Limitations of Leverage
The limits of leverage in the forex market vary from broker to broker. In order to ensure that retail traders do not take on too much risk, the commission recommends leverage ratios of 30:1 on major currency pairs and 20:1 on other currency pairs.