What is the Use of Leverage When You Trade Forex?

August 6, 2021 Tom Clark | Comments Off

A lot of retail Forex traders take advantage of the amount of leverage being offered in Forex trading. In fact, people get drawn to trading because of leverage. With leverage, traders can gain exposure to financial markets more than the amount they have paid or capable of paying. Forex traders should know how to properly use Forex leverage so they can maximize its advantages and also take responsibility for it.

What is leverage and why is it important in Forex trading?

Leverage when you trade Forex is a vital tool in trading in allowing traders to increase their exposure to the market without the need to take on huge investments or initial deposits. For instance, you can enter a position of $10,000 only by paying the margin of $1000. The leverage ratio for this is 10:1. But this doesn’t mean that you will have guaranteed gains at all times. In fact, if the gain is doubled, the losses are also magnified. In a worst-case scenario, you will end up losing so much, even your deposit money that you will be prompted to deposit again just to continue with your trades.

In a leverage ratio of 10:1, traders gain exposure to a trade size that’s ten times the deposit or margin which is required to open a trade. This is similar in real estate, or when you buy a house. You pay the 10% initial deposit before you can live in the house.

Most of the time, the amount of leverage that traders get depends on the broker as this amount varies according to regulatory standards that are available in different regions.

Difference of Leverage in Forex and Leverage in Shares

When you say leverage, it is not just available in Forex but on Shares also. Forex trades show a different amount of leverage as with trading shares. The reason for this is because major Forex pairs are very liquid with less volatility even though they are the ones being traded more frequently. This results in hedging risk and manageable trades, especially when getting in and out of the market.

Managing Forex Leverage Risks

Unfortunately, it isn’t always great to trade in leverage. This is because Forex leverage is a two-edged sword. It provides not just positive outcomes but negative outcomes too. Because of the risk that you’ll be facing when using leverage, it is necessary to determine a good risk management plan and effective leverage for your trades.

For experienced traders, their way of limiting the risk in leverage is through the use of stops. Also, it is recommended not to use more than 1% of your equity on a single trade and not more than $5 equity on all of your open trades.

The use of the risk-reward ratio is also a very good way to counter the risk of leverage in trading. As much as possible, it is also important to avoid making mistakes with leverage. These mistakes are sometimes brought about by a lack of basic knowledge about trading. Remember to take account of the money that you have invested to open your trades. Knowledge and finding reliable trading software are the best weapons you can have when you trade Forex.