What Is Leverage in Forex Trading?

Trading | 4 months ago


What Is Leverage in Forex Trading? - tradeglobalmarket

There are many reasons to trade forex as compared to stocks or commodities, but leverage is the reason that so many people are attracted to trading forex. While many beginners in forex trading have heard of the word "leverage," only few knows how it works and how it can directly impact their return on investment.

What Is Leverage?

In simple words leverage is the use of a short-term notational loan to increase the traders trading position size. In forex the loan or money is usually provided by broker.

How Leverage Works in the Trading Market?

To calculate the leverage, we make use of leverage ratio. This leverage ratio depends on brokers. Brokers around the world offer different leverage ratios based on your account size and your choice.

Brokers set their ratios as 1:50 or 1:100 or even more. So, for your account, if the ratio is 1:100 that means with the capital of $1, you can open positions for up to $100.

What Are the Benefits of Using Leverage?

Leverage improves the capital efficiency of a trader. So, if you have a trading account with leverage ratio of 1:100, Then for every $1,000 in your account, you can trade up to $100,000 in value. So, leverage can magnify your potential profit to a maximum extent.

What Are the Risks Involved with Leverage in Forex Trading?

Using leverage in forex trading has the potential to magnify your profits and magnify your losses by the same magnitude. To understand this, we will consider the following situations.

 

Trader x

Trader y

Initial Capital

$10,000

$10,000

Leverage Used

100 times

5 times

Total Position Size

$10,00,000

$50,000

In the Case of a 1% Loss in the trade

-$10,000

-$500

% Loss of Capital

100%

5%

% Of Capital Remaining

0%

95%


 

How to limit the Risks Associated with Leverage?

To limit the risk associated with leverage, a trader must make use of stop loss orders. This way a trader can protect their capital from an unexpected market movement.

Final Thoughts

If used sensibly, leverage is a great tool for traders to achieve profitable results with less capital. Leverage can be used successfully and profitably with proper risk management and strict stop loss.


 

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