Compared to other investment instruments, forex trading presents an attractive opportunity for many. One of the explanations for increasing attention to forex is the high leverage provided by most forex brokers. While experienced traders are aware of ups and downs of leverage, beginners often skip the basics and jump into live trading without a full grasp of what leverage is, how it works and how it impacts the risks and profits. So, first things first – let's clear up some facts!
What is Leverage?
Using forex leverage literally means borrowing money from your broker in order to be able to invest in trades. High leverage is offered because of the initial margin requirement. With leverage, your capital becomes 100 or more times larger and allows you to control and trade massive amount of money without actually having it!
How Much Leverage Can You Get?
Trading forex gives you a flexibility to choose leverage based on your financial status, trading strategies, risk management plan and personality.
In order to turn the minute price movements into decent profits, traders need to use leverage. The leverage varies from 50:1, 100:1 and 200:1. However some brokers dare to offer even larger leverage.
Let's consider an example:
With a deposit of $1,000 and leverage of 100:1 a trader is actually able to control the amount of $100,000. When you control large amount of money, small fluctuations in price of the currency may either bring amazing profits or devastating losses.
What is the Risk Involved?
Forex leverage can significantly enlarge your profits. At the same time, it can also expand your losses. The more leverage you apply on the money you actually have in the trading account, the higher risk is automatically attached to every trading decision you make.
Too Much is Never Good
It is crucial to stay away from greed at all cost and never trade amounts you cannot financially handle. Smaller leverage gives you a reasonable flexibility and a chance for wider stop/loss, therefore protecting you from risking to much of your trading cash.
High leverage can literally eat up your account within minutes, in case the trades go against your decisions. Be reasonable with your leverage selection and weigh the risks involved.
Google true stories on leverage use, and you will find the net full of disaster stories related to high leverage. It shows that excessive leverage almost always leads to excessive losses.
Not convinced yet? Consider the economic disaster that is still affecting the whole world. Investment banks were trading 40:1 leverage in some cases. The banking crises in US was caused by banks not buying based on solid fundamentals but rather using disproportional leverage to buy securities.
Forex trading success relies on slow and calculative decisions, rather than random guesses and hopes for millions by the end of this month.